Annuities are powerful tools for retirement, and an immediate annuity can help you be financially prepared. There are two types of annuities: deferred annuities and immediate annuities. A deferred annuity is where your premium grows over time, and you get a payout in the future.
With an immediate annuity, you pay a premium and start receiving payouts See note 1 soon after that. We'll go over the pros, cons and a few myths of immediate annuities, which are also called income annuities and single premium immediate annuities, or SPIAs. You can also check out our article that compares different types of annuities.
Immediate annuities are a great choice for people who want financial stability in retirement. By investing a lump sum, you can guarantee See note 2 an income stream for a certain amount of time or for the rest of your life. This will give you peace of mind and protection against longevity risk and market fluctuations.
However, this kind of investment also has some downsides. These include the potential to lose liquidity, risk inflation and miss out on higher returns from other investments.
Pros of immediate annuities
Guaranteed income for a certain number of years or for life
Some people might be spending their assets too fast in retirement, while others might be so worried about saving that they spend less than they could. An immediate annuity can provide a lifelong income stream so you can enjoy retirement.
Protection from market fluctuations
Investment returns can be variable and unpredictable. Negative returns - especially in the first few years of retirement, can increase the chances of running out of money before running out of time. An income annuity isn’t a security and is free from market fluctuations.
Longevity protection
Most of us want a long life, but longevity can multiply the other risks in retirement. Since no one can predict how long they'll live, it's hard to make sure you won’t run out of money. An immediate annuity can help manage this risk by ensuring a paycheck.
Simplified income management
Managing our finances as we grow older, or how others might take advantage of our financial resources needed for retirement, can be risky. An immediate annuity provides safe income stream that doesn’t need much maintenance.
Mortality crediting
The payouts from an immediate annuity have three parts: return of premium, interest, and mortality crediting. This last part, mortality or longevity crediting, is a unique and powerful feature of immediate annuities. This means that premiums from those who live shorter lives help pay those who live longer.
Death benefit
Some immediate annuities have a return of premium option. This means that if you die before getting back your initial premium, the remaining balance will go to your beneficiaries.
Cons of immediate annuities
Loss of potential growth
Immediate annuities give you income rather than long-term growth. If growth is your goal, you might want to look at other suitable investments.
Inflation risk
Fixed payments could lose their purchasing power because of inflation. Although some immediate annuities have an inflation adjustment, this would usually mean reducing the payout you receive.
Limited liquidity and control over payments
Once you pay a lump sum premium to the insurance provider, accessing your funds—aside from the periodic payment you receive as part of the contract—can be difficult, if not impossible. Once payments start, you normally cannot turn off the income stream. That's why it's important to carefully evaluate your situation to determine if an immediate annuity is appropriate for you going forward.
Fees and costs
Immediate annuities are usually associated with low fees or expenses. Nevertheless, the costs associated with an immediate annuity may be higher than other suitable alternatives. As with any financial commitment, it's essential to understand all related fees and expenses before committing.
Credit risk of the insurer
The insurer's ability to pay out an immediate annuity depends on its financial strength. Check the company's credit rating when you’re looking at immediate annuities.
Alternatives to immediate annuities
- Deferred annuities and certificate of deposits, or CDs, can give you a steady income and more flexibility to preserve your principal.
- Bonds or dividend-paying stocks. May offer potential for growth and income but are still subject to market fluctuations.
- Pension income: If you have a pension, this can be another excellent source of guaranteed income. Unfortunately, fewer organizations offer pensions these days, and you don't have much choice other than selecting who you work for.
Immediate annuity myths
The mention of just about any type of annuity conjures up many myths. When it comes to immediate annuities there are several unique myths worthy of dispelling.
- It's better to wait for higher interest rates to buy an immediate annuity. For those already retired and using other interest rate-sensitive assets for their expenses, immediate annuities can make even more sense. That's because of the mortality crediting component within immediate annuities, which isn’t affected by interest rates.
- Unlike my other investments, my money is tied up with an immediate annuity. Some people believe they can access their other assets whenever they want, but this is only sometimes the case. For example, if you're using Certificates of Deposit – CDs, for retirement income, you might think you can withdraw the principal amount anytime.
Technically, that may be true – not considering early withdrawal penalties, but since you rely on the interest from the CDs for income, withdrawing from them would reduce your income. So, even though you can access the money, doing so could negatively impact your retirement income. - The rate of return on an immediate annuity isn’t as high as other alternatives. Unlike many retirement alternatives, an immediate annuity is designed to pay you as long as you live. Therefore, with an immediate annuity the longer you live, the higher your rate of return.
- An immediate annuity is an "all-or-nothing" deal. However, it can be another arrow in your quiver of retirement income solutions. One strategy is to use the immediate annuity to cover at least your essential retirement expenses, allowing you to invest the rest of your portfolio for other goals or long-term growth. This can free you from the worry of meeting current expenses or the ups and downs of the financial markets.
Who should consider an immediate annuity?
- Retirees are seeking guaranteed income for a more worry-free retirement.
- Risk-averse investors who prefer stability over the uncertainty of the financial markets.
- Individuals with a long-life expectancy need assurance their savings will last.
Deciding whether an immediate annuity is right for you involves carefully assessing your financial situation, retirement goals, and capacity and tolerance for risk. Consulting with a financial advisor can provide personalized guidance, helping you make an informed decision that aligns with your long-term financial planning strategy. This choice can significantly impact your retirement comfort, making it crucial to consider all angles before committing.
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