Is An Immediate Annuity Right For Me?

is an immediate annuity right

Written by Hersh Stern Updated Saturday, July 7, 2018

Whether you are planning for retirement or are already there, an immediate annuity can bring you peace of mind, a secure future and extra benefits that you may not have considered.

An immediate annuity allows you to convert a lump sum of money – whether it’s from savings or another source such as an insurance payment or a real estate sale – into a regular payment that is guaranteed for a certain amount of time, even for the rest of your life. This type of annuity is called immediate because payments begin right away.

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5 Benefits of An Immediate Annuity

An immediate annuity provides much more than a steady payment.

Security -- By choosing the right type of annuity, you are guaranteed income for the rest of your life – even if you live way past age 100!

Simplicity -- Once an immediate annuity is set up, your work is done. There are no accounts to manage from year to year, and there are no worries about “timing” the market.

More Income -- An immediate annuity provides a lot more cash flow from your investment than other safe products like money markets and CDs can. That's because the annuity gives you some principal back in each month's check. So there's more cash for trips, holidays or the special people in your life.

Flexibility -- You have total control over how you set up your annuity. There are many payment options, which means you can pick the coverage that's best for you.

Safety -- While stocks may provide outsized returns in some years, there are no guarantees. Just one really bad market year can put you back for a long time. Annuities are guaranteed by insurance companies which have given stability to clients for hundreds of years, through good times and bad.

How to Size An Immediate Annuity in Your Retirement Portfolio?

An immediate annuity can ensure your living expenses are covered during retirement. To calculate how much annuity to buy start by adding up all your recurring monthly expenses. Then subtract all your guaranteed income sources, such as Social Security and defined benefit pensions. The gap amount is what you can fill with an immediate annuity.

You can also use our comprehensive retirement income calculator tool to calculate how much annuity income to buy.

There are other types of annuities for people at different stages of life. Someone who wants to delay income payments for three years or longer should probably consider a deferred income annuity or fixed index annuity, instead.

What Else Should I Consider When Thinking About Buying An Immediate Annuity?

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Comments (8)

  1. Terry:
    Oct 29, 2014 at 11:19 AM

    I am 67 and a friend says I'm too young for an annuity. Is that because what inflation will do to my monthly return over time?

  2. Hersh Stern:
    Oct 29, 2014 at 11:30 AM

    Hi Terry,

    I’ll respond with respect to immediate annuities. Keep in mind that there are so-called “deferred annuities” in which you can invest to create a bridge between your current age and the time when you are ready to “annuitize” or receive monthly income for life (if you wish to delay receiving income at your present age).

    First, I’ll present the facts about what is a typical age to be buying an immediate annuity. My answer draws on consumer research conducted by an independent research organization called LIMRA which publishes surveys and reports on trends in the insurance industry. The most recent LIMRA study on who is the typical buyer of an immediate annuity was issued in November 2010. (see link)

    http://www.limra.com/Posts/PR/News_Releases/Who_Is_the_Typical_Buyer_of_Immediate_Annuities___LIMRA_
    Study_Provides_Some_Clues.aspx

    At that time LIMRA’s researchers examined 50,000 immediate annuity contracts which were purchased in the prior year. LIMRA found that the average age at time of purchase for an immediate annuity was 73. The range of ages went all the way from age 40 to beyond age 90. So the midpoint was a person age 73.

    Since you are age 67 you are younger than the average person who bought such an annuity but there are millions of annuity buyers your age and younger, who buy them too.

    Regarding inflation and the loss of purchasing power that needs to be considered is a concern. You could add a cost of living rider to your immediate annuity or alternatively, limit the percent of your total assets that you spend on the immediate annuity and keep a portion in inflation sensitive products, so if inflation ramps up your “inflation-sensitive” assets will increase in value. Then you can periodically convert some of those assets into income streams at some future date in order to increase your spendable income.

    My main suggestion would be to consider an immediate annuity at your current age to be providing you with the secure income foundation upon which you can add less conservative (higher returning) investments which will hopefully keep up with inflation. You should consider discussing your plans with a fee-based financial planner to help you formulate your financial goals and figure out where an annuity may fit in your overall retirement income strategy.

    I hope I've answered your question to your satisfaction. Please reply to this comment if you have any questions about these annuities, or use the calculator on this page if you’d like to receive quotes. I’d also be happy to speak with you about your plans. I can be reached at 800-872-6684. I promise there will be no sales talk.

    -Hersh

  3. Tom:
    May 28, 2015 at 12:26 PM

    Why should I give you a million dollars to receive 5.42% and pay tax on part of the payment when I can buy a bond that pays 4.25% with no tax on the interest and still have my premium?

  4. Hersh Stern:
    May 28, 2015 at 12:51 PM

    Hi Tom-

    I’d first like to address your question about the income taxes.

    I sent you quotes showing you monthly income paid on a $1,000,000 premium. The highest payer on my list guaranteed to make monthly payments of $4,522. (Multiplying this number by 12 gives you $54,264 annually or 5.42% as you mentioned in your question.)

    The insurance company calculated that the taxable portion of the $4,522 income was $1,379.

    For purposes of this example, let’s say you are in the 30% federal tax bracket. Doing the math, you will owe income taxes in the amount of 30% of $1,379, which is $413, for each $4,522 check you receive. Subtracting $413 from $4,522 you see that your after-tax income is $4,109.

    Dividing $4,109 by $4,522 you arrive at 91%. So the bottom line is that while the income from an immediate annuity is not 100% tax-free, it is in reality 91% tax-free!

    You wrote that you were comparing the immediate annuity with an instrument which returned 4.25% tax-free. I’m curious to know what instrument guarantees a 4.25% tax-free income (in May 2015)?

    The second idea I’d like to share with you is that an immediate annuity is different from a bond because with the annuity you are actually amortizing the instrument each month. In other words, the insurance company does not have your $1,000,000 to invest and earn profits on for the duration of your payments.

    In fact, from the first month onward, the company is paying you back a chunk of your premium.

    If you apply the math you’ll see that over your lifetime the insurance company actually has on hand only HALF of one million dollars to work with. That is literally, the average amount it has available to invest.

    In the earlier years it has close to a million, but that number decreases month by month. So in the later years it only has half, then a quarter, an eighth, and eventually none of your premium on hand.

    Yet, if you live longer than the average person you will continue to receive the same original monthly income amount you started with when the company held a million dollars! That’s the beauty of an immediate annuity.

    To do the same with a bond you’d need to sell-off a bit of the principal each month. That’s tedious, there are transaction costs, if interest rates rise you’ll be eroding your principal more quickly, and if you outlive the maturity date of your bond, you may not find a replacement interest rate to maintain the withdrawal level you became accustomed to.

    All these risks are mitigated when you buy an immediate annuity.

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

    You can read more about bonds and annuities here:

    https://www.immediateannuities.com/immediate-annuities/bonds-or-lifetime-annuities.html

    As you review your quotes, please contact me again with any questions. Or, if you’d like to get updates to your numbers, or even to discuss your retirement plans, feel free to call me. I know this can get complicated.

    Hersh

  5. Julian:
    Jun 05, 2015 at 01:45 PM

    I have an opportunity to accept my employers offer of an annuity, or take a lump sum of $33k. The annuity, for life with 10 years certain, pays out $204 per month, which is more than what immediate annuities are currently offering. I assume there is a certain risk with accepting my employers offer, but it's a large name company, and for the size pension I'd be getting, it is well covered under the Pension Benefit Guarantee Corporation if necessary.

    I appreciate your input.

  6. Hersh Stern:
    Jun 05, 2015 at 01:45 PM

    Hi Julian,

    Good to hear from you.

    I agree that your employer’s monthly income quote is considerably higher than the quotes available from our representative insurance companies. I can explain why this is happening. The amount of your employer’s monthly pension is determined by your years of service and the rules in your defined benefit plan. This amount cannot be changed, it is guaranteed by the plan. When your employer calculates the lump sum equivalent in dollars to that monthly annuity, it uses an interest rate to “discount” the present value of those future payments. Your employer is likely using the 30-year Treasury Bond interest rate (referred to as the “GATT rate”) for this calculation. In other words, the $33,000 you are promised by your employer was calculated based on the 30-Year Treasury rate as the discounting rate.

    Insurance companies, however, are not crediting as high a rate in their annuities today as the 30-Year Treasury bond offers. So the $33,000 premium is not generating as high a monthly income quote from the insurers as your plan is promising to pay you.

    Please let me know if you have any questions. I’d also be happy to speak with you about your plans.

    -Hersh

  7. Lora:
    Jun 15, 2015 at 02:11 PM

    Are annuity payments electronically deposited or do they mail the checks? Also, if I start receiving payments than move to another state, can I switch my payments to a different bank?

  8. Hersh Stern:
    Jun 15, 2015 at 02:14 PM

    Hi Lora,

    The answer to both is yes.

    Insurance companies allow for direct deposit into a bank account when receiving payments from your annuity. Some even require it. The majority will still allow for paper checks as well.

    One thing to note: when you purchase an immediate annuity, you are given a payment start date. This is the date that the insurance company releases the funds. However, it usually takes a few days from that date to wind up in your bank account due to processing times, even longer if your payment date lands on a holiday or weekend.

    There is no problem changing your direct deposit, should it be due to a move from one state or another, or a simple change in banks. All you would need to do is fill out a form and send it to the insurance company along with a new voided check.

    The only issue that may arise would be if you were to move out of the country. Then you would need to make sure you choose a bank which has both US and international branches, Citibank, for instance.

    -Hersh