What Is An Immediate Annuity?

Written by Hersh Stern Updated Friday, February 13, 2015

A Single Premium Immediate Annuity (sometimes referred to as an "SPIA") may be the right annuity for you if you are looking for payments that begin right away and continue for the rest of your life or for a specified period of time. The annuity is purchased from an insurance company with a single, lump sum amount called a premium.

How does an immediate annuity work? In return for your lump sum, the insurance company promises to make regular payments to you (or to a payee you specify) for the chosen length of time – most commonly for the remainder of your life, however long that may be.

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In most instances, immediate annuity payments are sent to you starting one month after you buy your annuity. When choosing an immediate annuity, you can choose how frequently you receive payments – often referred to as the “mode.” While annuity buyers typically choose to receive payments monthly, you may choose quarterly or even yearly instead.

In today’s immediate annuity marketplace, there are a number of ways the annuity can be customized to suit your specific life situation and concerns. In exchange for the guarantee of payments, you give up the right to demand the return of your original premium. Unlike some forms of life insurance or other types of annuities, you are generally unable to revise or cash in the immediate annuity once the 10-day "free look" period has passed.

You can fund your immediate annuity in a number of ways, including cash from a maturing Certificate of Deposit (CD), exchanging monies accumulated in a Multi-Year Deferred Annuity account, proceeds from the sale of stocks, bonds, a home or a business, a lump sum distribution from a tax-qualified defined benefit or 401k, or an IRA account.

Why should I consider buying an Immediate Annuity? What are its advantages to me?

An immediate annuity comes with many important advantages. Here are just a few:

Security — The annuity provides stable lifetime income which can never be outlived or which may be guaranteed for a specified period. This advantage is crucially important to annuitants who may have previously feared outliving their savings.

Simplicity — An annuity is pretty much “get it and forget it.” Once it is set, the only work you are required to do is collect your regular payments. With an immediate annuity, you do not need to watch markets or track interest rates and dividends.

Higher Returns — The interest rates used by insurance companies to calculate immediate annuity income are generally higher than CD or Treasury rates. Since part of the principal is returned with each payment, greater amounts are received than would be provided by interest alone.

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Preferred Tax Treatment — An immediate annuity may be a good strategy to defer taxes until later in your retirement when you may be taxed at a lower rate. This differs from other types of annuities for which the tax burden is “front loaded.”

Safety of Principal — Funds are guaranteed by assets of insurer and not subject to the fluctuations of financial markets.

No sales or administrative charges — Immediate annuities do not have annual account management or maintenance charges. 100% of your premium goes towards your monthly income.

How can you customize an immediate annuity?

You may hear a lifetime immediate annuity called by a number of different names, including "Single Life," "Joint Life," "Life and Period Certain", or "Refund" annuity. Regardless of its name, by ensuring that you will never outlive your income, a life annuity is a powerful retirement planning tool. What’s more, a life only annuity generally offers the highest payout of any lifetime annuity, because it carries the smallest risk for the insurer.

When you shop for an immediate annuity, you will find that one of the key factors in pricing is your age and life expectancy. In a sense, purchasing an immediate annuity is like making a bet with an insurance company about how long you will live. Since the insurer will stop making payments when you die, it is betting that you won't live beyond your life expectancy. On the other hand, if you live longer than predicted, your return may be far greater than estimated.

Immediate annuity coverage can be increased by including a second person ("Joint and Survivor" annuity), by adding a guaranteed period of time ("Period Certain" annuity), or by guaranteeing that payments will continue at least until the original purchase amount has been paid out ("Refund" annuity). This added risk to the insurer is likely to reduce monthly payments by about 5% to 15%, depending on the age of the annuitants and the length of the guarantee period.

You may want to consider an immediate annuity with special options if:

1. You wish to guarantee lifetime income for both yourself and a spouse ("Joint and Survivor" annuity)

2. You want payments to continue for a specified period (e.g. 5 or 10 years or more) to a designated beneficiary ("Certain and Continuous" annuity)

3. You want to ensure that should you die before your initial principal has been distributed, an amount equal to the balance of the deposit continues to a named beneficiary ("Refund" annuity).

What about funding my annuity? Can you explain the difference between qualified and non-qualified funds?

The way your annuity payments are taxed depends upon the source of the funds you use to purchase it.

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Qualified Immediate Annuities

When applied to immediate annuities, the term qualified refers to the tax status of the source of funds used for purchasing the annuity. These are premium dollars which until now have "qualified" for IRS exemption from income taxes. The whole payment received each month from a qualified annuity is taxable as income (since income taxes have not yet been paid on these funds). Qualified annuities may either come from corporate-sponsored retirement plans (such as Defined Benefit or Defined Contribution Plans), Lump Sum distributions from such retirement plans, or from such individual retirement arrangements as IRAs, SEPs, and Section 403(b) tax-sheltered annuities, or Section 1035 annuity or life insurance exchanges.

Non-qualified Immediate Annuities

Non-qualified immediate annuities are purchased with monies which have not enjoyed any tax-sheltered status and for which taxes have already been paid. A part of each monthly payment is considered a return of previously taxed principal and therefore excluded from taxation. The amount excluded from taxes is calculated by an Exclusion Ratio, which appears on most annuity quotation sheets. Non-qualified annuities may be purchased by employers for situations such as deferred compensation or supplemental income programs, or by individuals investing their after-tax savings accounts or money market accounts, CD's, proceeds from the sale of a house, business, mutual funds, other investments, or from an inheritance or proceeds from a life insurance settlement.

Comments (19)

  1. Gloria Tailor:
    Nov 18, 2014 at 09:23 AM

    What happens to the principal after the annuity expires?

  2. Hersh Stern:
    Nov 18, 2014 at 09:28 AM

    Hi Gloria,

    What happens to the premium (i.e., the amount you paid for your annuity) depends completely on the type of annuity you purchase. There are annuities that return the full principal plus earnings. These are known as fixed interest, multiyear, or index annuities. Keep in mind, if your goal is to withdraw the full principal in the end, then during the life of your annuity the most you can remove each year will be limited to the annuity’s earnings.

    With an immediate annuity, the type that distributes to you a portion of your principal plus interest each year during your lifetime, in the end all the principal will have been paid out to you, so there is no principal left to pay out. You can protect your beneficiaries even with an immediate annuity by selecting one with a refund option. That way, if you died before all the premium was paid to you while living, the unpaid balance would go to your heirs.

    Let me know if you have any more questions by calling me at 800-872-6684 or by posting any comments or questions here.

    -Hersh

  3. Dwayne:
    Jan 09, 2015 at 10:43 PM

    What is the minimum amount you can purchase one of these for? Thank you.

  4. Hersh Stern:
    Jan 14, 2015 at 02:54 PM

    There is no minimum premium amount that would apply for all insurance companies. Some require at least $10,000 to $25,000 investment. Others require that the modal payment (typically, monthly) be at least $100. You can meet these companies minimums by electing quarterly payments for a minimum of $100 every three months.

    A more important consideration might be how much in liquid assets will you have after you buy the annuity? If you’re thinking along the lines of a minimal investment, will you retain at least that same amount in cash for emergencies?

    -Hersh

  5. Gordon B.:
    Jan 14, 2015 at 03:00 PM

    Can the distribution from a SPIA be considered as part or all of the RMD of an IRA where part of it has been used to fund the SPIA?

    The payout of the SPIA would be used to purchase a whole life insurance policy.

  6. Hersh Stern:
    Jan 14, 2015 at 03:01 PM

    Hi Gordon,

    How you spend the RMD (whether to fund a life insurance policy or for traveling abroad) will not impact the answer to your question.

    Generally, an SPIA is considered to satisfy RMDs beginning in the 2nd policy year for life. So you do not need to figure RMDs with respect to the IRA money that you use to buy the annuity. By the same token, your monthly payments received fro the IRA annuity are not applied to satifying the RMDs of your non-annuity IRAs.

    You can read more about this here:
    https://www.immediateannuities.com/required-minimum-distribution/

    -Hersh

  7. Jack:
    Jan 16, 2015 at 10:05 AM

    Can I purchase an immediate annuity by combining money from my IRA with the proceeds from the sale of stocks? I want to fund the annuity with a combination of these two sources.

  8. Hersh Stern:
    Jan 16, 2015 at 10:25 AM

    Unfortunately, you cannot comingle IRA (so-called “qualified” money) and “non-qualified” money in the same immediate annuity contract. However, you can buy two separate annuities where the combined premium equals the total amount you were looking to invest. The good news is that immediate annuity pricing is mostly proportional, so you won’t lose much monthly income by splitting your premium into two annuities.

  9. Meredith:
    Jan 16, 2015 at 10:37 AM

    I have just been told that the problem with "Immediate" annuities is that they are only guaranteed for life expectancy, so that if one outlives the expectancy--which might very well happen in my case, as we tended to be long-lived in our now largely departed small family--the payments abruptly stop. My understanding, based on your webpage information, was that "life" meant life, and that payments continued until one died, regardless of when that occurred. But obviously I would need to know . . .

  10. Hersh Stern:
    Jan 16, 2015 at 11:37 AM

    Life annuities in the U.S. by law pay the recipient for as long as he or she is living. They do not stop if you are alive. It’s really that simple. I don’t know what you may be hearing but the only annuity that would stop even if you were living would be a “Period Certain Only” annuity not a “Life” annuity.

    When you request quotes you’ll find explanations telling you how these are administered by the insurance companies.

    If you request from us any "Single Life" quote, the page listing those quotes will have the following explanation: "You receive this income for as long as you are living."

    This has nothing to do with payments just for life expectancy. These are payments for as long as you are living even if it is till age 150+ or later (LOL).

    -Hersh

  11. Michael:
    Jan 22, 2015 at 10:45 AM

    What exactly does it mean by qualified and non qualified premiums? $5,000 and $10,000 premiums???

  12. Hersh Stern:
    Jan 22, 2015 at 11:20 AM

    Hi Michael,

    The term qualified (when applied to Immediate Annuities) refers to the tax status of the funds used for purchasing the annuity. These are premium dollars which until now have “qualified” for IRS exemption from income taxes. The whole payment received each month from a qualified annuity is taxable as income (since income taxes have not yet been paid on these funds).

    Qualified annuities may either come from corporate-sponsored retirement plans (such as Defined Benefit or Defined Contribution Plans), Lump Sum distributions from such retirement plans, or from such individual retirement arrangements as IRAs, SEPs, and Section 403(b) tax-sheltered annuities.

    Non-qualified annuities are purchased with monies which have not enjoyed any tax-sheltered status and for which taxes have already been paid. A part of each monthly payment is considered a return of previously taxed premium and therefore excluded from taxation.

    The amount excluded from taxes is calculated by an Exclusion Ratio, which appears on most annuity quotation sheets. Nonqualified annuities may be purchased using after-tax savings accounts or money market accounts, CD’s, proceeds from the sale of a house, business, mutual funds, other investments, or from an inheritance or proceeds from a life insurance settlement.

    -Hersh

  13. Thomas:
    Jan 26, 2015 at 09:14 AM

    I’m considering the purchase of a joint life annuity with 50% to the survivor. I received quotes from different agents and the numbers are different if the 50% payout only goes to the survivor as compared to when the 50% payout goes to either of us when the other person dies. Can you please explain the difference and which type make more sense.

  14. Hersh Stern:
    Jan 26, 2015 at 09:48 AM

    Hi Thomas,

    You correctly observed there are two forms of reduced joint and survivor annuities and insurance companies administer them differently.

    Type 1. Joint & Survivor Reducing to 50% on the Death of the Primary Annuitant only.

    With this type of joint life annuity you receive the initial income amount for as long as both of you are living. Upon the death of the primary annuitant only, the secondary annuitant’s income is reduced to 50%. If the joint (second annuitant) is the first person to die then there is no reduction in income paid to the primary annuitant.

    Type 2. Joint & Survivor Reducing to 50% on Either Death

    Here again the initial income amount is paid for as long as both of you are living. However, upon the death of either annuitant, the survivor’s income amount is reduced to the 50% level.

    The first option is also known as the "ERISA" form of joint annuity since it was mandated under the Employee Retirement Income Security Act of 1974. Employers of defined benefit plans are required to offer this joint life annuity option to their retirees because the annuity originates from the retiree's service to his or her company. So the law was written to protect the employee in the event his or her spouse died first, so that the original income level would not be reduced.

    There is a difference in cost between these two options. For example, if you asked an insurance company how much would it cost to buy a $500 a month lifetime income under each option, the 2nd type, which reduces on either death, would be cheaper. The reason is that with a "reducing on either death" annuity there is a greater probability that the reduction will occur sooner seeing as the reduction happens when either of you dies. Those are greater odds for a reduction than in the first annuity option where a reduction in income only happens when the primary annuitant dies but never when the second annuitant dies. So with this option it’s less likely for the cut to happen.

    If you’ve been able to follow me so far you know the company actuaries would understand this, too. So they make sure to pay you a smaller starting income under the first option because they expect you to receive that higher initial amount for a longer period of time. There, now you can sit for your advanced actuary’s exam. LOL

    -Hersh

  15. Richard:
    Feb 02, 2015 at 02:26 PM

    Can a LLC purchase an immediate annuity for a manager?

  16. Hersh Stern:
    Feb 02, 2015 at 02:53 PM

    Hi Richard,

    Yes, an LLC can buy an immediate annuity and either retain ownership or distribute ownership to an individual. There are tax ramifications for each approach.

    Briefly, if the LLC retains ownership and only the monthly payments go to the annuitant, then the LLC receives a Form 1099 (reporting the income to the IRS) at the end of the year and can issue a “wash” 1099 to the annuitant under nominee income rules. In this case the individual is generally not taxed for receipt of the value of the whole annuity (i.e., constructive receipt of the premium paid for the annuity). However, since the LLC remains the owner, the payments could be redirected away from the annuitant to someone else down the road. So the annuitant is not protected from that possibility.

    The alternative approach would be for the LLC to pay the premium up front and then transfer ownership of the annuity to the individual. That would likely trigger constructive receipt and the annuitant would owe income taxes on the full value of the annuity in the year he or she “receives” it. (Of course, the LLC could also “pre-pay” the taxes by grossing up its annuity value above what is owed to the individual.)

    Best to consult a tax attorney about these matters. There may be ways to set this up in a trust to avoid or delay taxes.

    Hersh

  17. Janet:
    Feb 06, 2015 at 02:32 PM

    My mother is recently widowed. We are looking to buy an annuity that will provide income and shelter as much as possible of her assets, in case she needs to enter a nursing home in the future. What would be the best type of annuity and the best way to set it up?

  18. Hersh Stern:
    Feb 06, 2015 at 02:57 PM

    Hi Janet-

    I would love to help you. In many states an annuity can help your mother maintain eligibility for Medicaid. However, Medicaid laws prohibit me from advising you how to go about that. May I suggest you first consult with an attorney who practices elder law and knows the Medicaid legibility laws in your mother’s state of residence.

    Then if your attorney advises you to go ahead with the annuity, contact me again and I would be happy to help you. But I’m not permitted to advise you to take that action. And again, yes, there are many states where an annuity can help, but the purchase should be directed by your attorney.

    I hope I've answered your question to your satisfaction.

    -Hersh

  19. Brian:
    Feb 07, 2015 at 11:58 AM

    I just stumbled upon your website.

    We are currently working with a CFP for our retirement planning.

    Thank you for your website & sharing your knowledge.

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