What Is an Immediate Annuity?

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Immediate annuities are a financial product that allows you to deposit a lump sum of money, and start collecting payments immediately. You can set up your annuity to make payments to you for a set period of time, or for life.

Immediate annuities are one of the simplest ways to create a fixed income in retirement to help supplement other income sources. But annuities can come with complicated terms and high fees.

This article breaks down how immediate annuities work, the different types of immediate annuities to choose from and how to buy an immediate annuity.

How Does an Immediate Annuity Work?

An immediate annuity is an insurance contract between you and an insurance company. You typically fund an immediate annuity with a large lump payment up front — such as $100,000, and in return, you’ll get a regular payment from the insurance company for a predetermined period — or for life.

The name “immediate” comes from the fact that you start receiving payments right after you fund the policy. This is opposed to a “deferred” annuity that defers payments until after a set period of time.

The Single Premium Immediate Annuity (SPIA) is the simplest and most common type of immediate annuity to choose from. You’ll make a single deposit, and funds are then distributed over the time frame you select. You’ll want to select a payment schedule that works with your financial goals when purchasing an immediate annuity. Most immediate annuities allow you to choose between monthly, quarterly or annual payouts.

You’ll receive returns — and payments from your annuity based on a few factors, including:

• Your age: If you choose lifetime payments, your age will play a factor in your payment amount. In general, the younger you are, the lower your payments will be based on a longer life expectancy.
• The amount you deposit: Your lump sum deposit will determine how much you get paid out from your annuity. Payment calculations can get complicated, but the larger your lump sum, the larger the payment in most cases.
• The type of annuity: There are several types of annuities, with returns tied to interest rates or underlying investments. The type you choose will affect your payment amount.

Although annuities are not life insurance, top-rated life insurance carriers often underwrite them. The insurance company manages the annuity to guarantee the return.

Benefits of Immediate Annuities

There are several benefits to immediate annuities as an investment strategy:

• Guaranteed income for life or a set period: Immediate annuities offer steady, fixed payments that have a guarantee. This helps investors plan for retirement in a simpler way, with steady income to count on.
• Simplicity since you don’t need to actively manage it: Immediate annuities are not like investing in stocks — you can set it and forget it. You simply make a lump sum deposit, set up a payment schedule and start receiving checks.
• Tax advantages for certain types of annuities: Some annuities offer tax-free growth and the ability to borrow against your annuity cash value on a tax-free basis and defer taxes on capital gains until you withdraw.
• Low-risk nature compared to other investments: Immediate annuities offer guaranteed returns and can offer fixed interest rates — making them a low-risk investment for fixed income in retirement.

Types of Immediate Annuities

There are several types of immediate annuities to choose from:

Single-Life Immediate Annuities

A single-life annuity puts money in your pocket from the starting date throughout your lifetime. Keep in mind, if you don’t live long enough to receive the full amount you invested, you could lose money. However, you could come out ahead with a higher return if you live longer than the insurance company expects.

If you don’t have a spouse or other surviving dependents, this could be the best choice.

Joint-Life Immediate Annuities

A joint-life immediate annuity is similar to a single-life annuity, except there are two beneficiaries — the annuity pays through the lifetime of the last surviving spouse.

If you have other heirs, such as children or grandchildren, you can add a death benefits rider to this annuity, which means that the remainder of the funds in the annuity can be passed onto an heir.

Period Certain Immediate Annuities

A period-certain annuity, or fixed-period annuity, pays benefits for a predetermined amount of time, typically between five and 30 years. This can be a good option for retirees that want fixed income guarantees for a set amount of time — such as until the house is paid off.

If there is money left over in the account, you can roll them into another annuity, withdraw them in a lump sum, or roll them into another retirement account type. You may also be able to extend the annuity contract. 

Specified Amount Annuity

A specified amount annuity pays a set dollar amount. Once that amount has been paid, payments stop. The amount of the required lump sum for a specific amount annuity is determined by how much you want each period, and how often you want to get paid.

This is best for investors that have a set number in mind for monthly payments, and then can just fund the immediate annuity with enough to hit that income goal.

Immediate Annuity Payouts: What To Expect

The amount you get paid and how often you get paid from an immediate annuity is based on a variety of factors. Here’s how immediate annuity payouts are determined:

Age, Gender and Health

Your age, gender and current health status are taken into account by the insurance company to determine your payout schedule and amount to pay. In general, the older you are, the more you’ll get paid each time — monthly, quarterly or annually. Since women tend to live longer than men, men usually have higher payouts than women, as insurance companies assume men will have a shorter lifespan.

Type of Annuity

The type of annuity you choose can also impact your payouts. Some immediate annuities offer fixed interest rates with lower returns, and may have lower payments than annuities that allow you to “invest” your funds for more potential growth.

Payment Schedule

The schedule you choose for your payments will determine the payouts. Monthly payments are obviously going to be smaller than annual payments.

Location

Your location may affect the payout for your specific annuity.

Keep in Mind

Keep in mind, a fixed-term annuity will pay the same amount, regardless of age or gender. A $100,000 annuity with a term of 5 years will pay $1,844 per month. A 10-year fixed-period annuity will pay $1,032 per month, based on the calculator at ImmediateAnnuities.com.

Here’s a look at payouts for someone with a lump sum investment of $100,000 living in Florida at various ages.

Payouts change, however, with a lifetime annuity.

You can see how it might make sense to roll over another investment into an immediate annuity for consistent income, especially in your later years. If you are getting close to retirement, or have already retired, and fear you may not have enough money to last through your later years, an immediate annuity could be a solution. If you are in good health, you might consider a single-life income annuity, which will pay you a fixed return for your entire life.  

How To Purchase an Immediate Annuity

Purchasing an immediate annuity can help you set up fixed income right away. Here’s how to purchase an immediate annuity:

1. Research and compare providers: Insurance companies offer annuities at different rates, with varying fees. You’ll want to review providers and find a few that have a good reputation and annuity terms that you want.
2. Understand fees and terms: Review the fees associated with your annuity, and the terms and conditions of the contract. Some annuities may have hidden fees that include, underwriting, account management, early withdrawal penalties, surrender charges, administrative fees and commissions. You’ll want to ask questions of your insurance agent for anything you don’t understand — especially on how fees work within the contract.
3. Request multiple quotes and evaluate options: As with any other major purchase, you want to shop around and get multiple quotes. You can do this easily online, so you will have the quotes in writing. Most quotes are good for a week or two, so take your time but don’t wait too long to make your decision.
4. Choose a provider with strong financial ratings: It’s important to review the AM Best ratings for any insurance company that you plan on getting an annuity from. This can give you an idea of the financial stability of the company, which in turn gives you peace of mind that they have the ability to make payments on your annuity.

Alternatives to Immediate Annuities

Many investors shy away from immediate annuities because they can be complicated to understand. Hidden fees can diminish your earnings and the returns are not as good as many other investments. Plus, to open an immediate annuity, you’ll need a lump sum of cash.

Here are a few alternatives to consider:

Deferred Annuity

If you prefer to let your investment build over time, a deferred annuity might be a better option. With a deferred annuity, the investor makes monthly premium payments, either on a tax-deferred basis or with after-tax dollars. Then, they can begin making withdrawals after a certain amount of time.

Bonds

Bonds are another form of stable, predictable income. You can create a bond ladder, where bonds mature at different times, to create a stream of income. Or you can invest in a bond fund that offers diversifications along with monthly payments.

High-Yield Savings Account

In today’s market, a high-yield savings account can provide a return as high as 4.00% APY. While you won’t see any tax advantages to a savings account, it provides easy access to your money when you need it.

Dividend Stocks

For less risk-averse investors, dividend-paying stocks can also provide steady income. You can build a small portfolio of dividend stocks and collect quarterly dividend income while investing in quality companies.

Dawn Allcot contributed to the reporting for this article.

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