What is an immediate annuity?
An immediate annuity is a tool in the form of a contract that pays income over time based on the assets you provide to the insurance company. Payments often start in the month you purchase the immediate annuity, but details may vary depending on your specific contract.
How does it work?
When using an immediate annuity with a lump sum, you deposit a monetary amount (the premium) with the insurance company. The company then pays you a fixed income. For example, you might receive monthly or annual payments. These payments may come in the form of paper checks or electronic deposits directly into your bank account.
Can I stop the payments?
Once you purchase the immediate annuity and start receiving income (also known as “the annuity”), in most cases there is no way to go back. When you decide it is time to start receiving payments, that choice is irreversible. There may be ways to withdraw, but that will depend on the terms of your specific contract, and it can be complicated and costly. It may not suit your needs as well. Remember, in exchange for your upfront payment, the insurance company has promised to pay you a fixed amount over time. In most cases, you receive a larger amount if you can commit to an irrevocable payment flow in writing.
Can I specify when payments start?
An immediate annuity is different from deferred annuities, which hold your money and invest it similarly, but may have less strict rules regarding how you use and access the funds. Most deferred annuities allow you to withdraw funds anytime you wish, transfer your assets, or withdraw them (although you may face tax consequences when doing so).
Note: Just because the insurance contract allows you to take certain actions does not mean those actions are in your best interest. For example, if you withdraw funds or transfer money between accounts or withdraw them entirely, you may incur fees and taxes.
How much do insurances pay?
The amount of income you receive monthly and over time depends on various factors. It may be obvious that the more you contribute upfront, the more you will receive in the future. You also have several options for how payments are made. For example, you may choose from one of the following common options:
- Lifetime: Guaranteed payments for the rest of your life, regardless of how long you live
- Fixed period: Payments for 10 or 20 years, with beneficiaries receiving any remaining payments if you do not live that long
- Joint lifetime: Payments continue as long as you or your spouse are alive
- Other options: The insurance company may offer you various other options, depending on individual circumstances
Typically, the largest payments come with the first option – single life income. If you want payments to continue as long as two individuals are alive, the insurance company takes on more risk and will reduce payments based on that factor.
What happens upon death?
If you convert your money into lifetime income and choose continuous payments throughout life, payments stop upon death (or the second death, if you chose joint lifetime payments). Whether you will be in a better position or not depends on several factors. When choosing an option for payments, you should consider all outcomes, including the lifespan you believe you will live. Insurance companies devote huge resources to analyzing risks, and they are very skilled in statistics. It is likely they have analyzed a complete range of outcomes and assigned values to each of them. If you live a very long life, you may end up receiving a larger amount than you expected. But if you pass away within two months of receiving income and did not choose a “fixed period” (like 10 years), the insurance company retains the original amount you contributed to the annuity upon enrollment.
Note:
Unless you can predict your lifespan, there are always some risks associated with using an immediate annuity. Therefore, it is essential to evaluate the risks and compare the options.
You may be able to spend your assets without ever turning to an insurance company at all. Or perhaps you can build your retirement with guarantees or limits, so that only a portion of your assets is invested.
Costs and Risks
In addition to the risks of living a short life, immediate annuities can be complicated tools. While some of the more common options are listed above, the number of available options is immense. Many service providers offer a wide variety of choices, such as those that protect against inflation, or customized riders of all kinds that can be added to the base contract. Note that there will always be a price for extra features. The tricky part is that you don’t always see the “cost” appear as a clear amount when you’re in the planning and purchasing stage. Instead, you may be paying an opportunity cost, as you cannot predict what will happen in the future; you can only guess, and the insurance company is betting on a wide range of outcomes.
Another risk is the chance that your insurance company could fail. Insurance companies are not protected by the government, unlike banks insured by the FDIC or credit unions. Therefore, be sure to conduct the necessary research and choose strong insurance companies (which hopefully remain secure throughout your lifetime).
Conclusion
Buying an immediate annuity is a significant decision. It can provide retirement income, just like the paychecks you received during your working years, but it’s not suitable for everyone. Read your contract and all insurance documents carefully, as terms may vary from policy to policy. It is also best not to assume that you know how your assets will be treated or how your income will be paid. Talk with a financial planner or a trusted insurance agent if you have any doubts. It is also wise to discuss your goals and all options with a professional or someone you trust before making a decision.
Source: https://www.thebalancemoney.com/immediate-annuity-definition-and-explanation-315095
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