What is an Immediate Annuity?
An immediate annuity is an option that allows a person to take a portion of their savings or retirement and create an immediate income stream that often starts within 12 months. They typically provide lifetime income but some options do allow for full withdrawal in as little as 5 years.
What Are The Payout Methods?
Life Only allows an annuitant to receive income payments for life, even if their entire funds are exhausted. Once the annuitant passes away, the income stops. This option bears the highest amount of risk. For example, if an annuitant pays a single premium of $100,000 but only received $30,000 before they passed away, the remaining $70,000 is kept by the insurance carrier. As a general rule of thumb, this payout method results in the highest lifetime monthly benefit.
Life With Cash Refund still offers lifetime income to an annuitant, but eliminates the risk of losing their premium to the insurance carrier. Instead, if anything remains when the annuitant passes away, money is paid to a beneficiary. This will usually result in the lowest monthly income benefit because there is significantly less risk.
Life With Period Certain offers lifetime income to an annuitant, yet offers a partial guarantee. For example, let’s say a person chooses Life with a 10 Year Period and pays $100,000 into the annuity. Let’s also assume the annuity will pay $8,000 per year. In this example the guarantee comes in the form of time rather than money. So if the annuitant passed away after the eighth year, two years of payments would get paid to a beneficiary in a lump sum. In this case, $64,000 had been paid to the annuitant and $16,000 would get paid to a beneficiary. If you do the math, this means the insurance company walked away with $20,000.
Period Only takes away the lifetime income component if your goal is to receive all of your money in a specific amount of time. This might be the case if you know that longevity does not run in your family. Eliminating the lifetime component will increase your monthly benefit.
Immediate Annuity Versus Systematic Drawdown Strategy
The biggest problem associated with a systematic drawdown strategy from your 401(k) is the risk of exhausting all of your funds. An immediate annuity takes that risk away by offering lifetime income.
Why Not Withdraw All of My Retirement Money in a Lump Sum?
Tax implications are a huge reason you may not want to choose this method. In most cases, a lump sum will put you into a higher tax bracket, which means more of your retirement money is going to Uncle Sam, and not your retirement.
Who Should Buy An Immediate Annuity?
Immediate Annuities are typically purchased by people age 55 or older. These are people who have just retired or are looking to retire soon and want to start an immediate income stream. Buyers of immediate annuities need to be very certain that they want an income stream because there are not usually any options for surrendering the contract. There are guidelines to make sure people are not using more than 50% of their total liquid net worth.