Why You Should Use Immediate Annuities
Purchasing an immediate annuity is one way to ensure that you and your spouse will not outlive your retirement savings. If you think you have enough to get by, think again; while many people anticipate living another 15 or 20 years past 65, you or your spouse has a 50 percent chance of living into your nineties. One way to guarantee income past retirement, no matter how long you live, is to purchase an immediate annuity.
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What is an immediate annuity?
An immediate annuity is an insurance product, sold by an insurance company. The company agrees to provide a certain sum to you on a systematic basis in return for your investment of a lump sum of cash, and payments do not cease past a certain age. In fact, they will continue until the day you pass, even if the insurance company realizes a loss. Profit is made for the company when an investor dies earlier than expected because the principal is not passed to his or her heirs; rather, the insurance company pockets this principal upon the death of the beneficiary. Rates are determined so that overall, the company will see a profit. Rates are also dependent upon the amount invested, your age, and current interest rates.
Immediate annuities can be purchased for you (a single-life annuity), for you and another party, such as your spouse (called a joint-life annuity), or for you and your spouse with a guaranteed, fixed payout term should both parties pass away within ten years of purchasing the annuity (called a joint-life annuity with ten years certain). In the latter case, annuity payments will continue to your heirs. Longer terms can be purchased, but keep in mind that the longer the insurance company expects to make payments, the smaller each payment will be.
Why are annuities not used more often?
Despite all the obvious benefits and the ease of using immediate annuities, not enough retirees make them a part of their retirement portfolios. Perhaps one reason is because of the confusion associated with the word "annuity." Two kinds of annuities exist. The type discussed above, an immediate, or lifetime, annuity, simply provides a guaranteed flow of income to a beneficiary until death.
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Another kind of annuity is a deferred annuity. This type functions by reinvesting any income back into the annuity, allowing earnings to accumulate. Accumulated earnings are not taxable until they are paid, and earnings are paid upon the beneficiary reaching a certain mature age, for example, 85; this is called annuitizing. Unfortunately, many people die or voluntarily withdraw the money before annuitizing.
When purchasing an immediate annuity, you can choose to invest in a fixed annuity, in which investments are made in bonds, or in a variable annuity, in which investments are made in stocks. Often, insurance companies will protect investors in variable annuities in the case of a large stock market dip.
Will I be charged a commission if I purchase an annuity?
While salesmen will not explicitly charge you a commission, insurance companies will pay large upfront commissions, which are then repaid from the policy over the course of years. Should you purchase an annuity and then decide to cash out early, expect to pay heavy fees. These fees are usually called "charges" but function as incognito commission payments. Otherwise, you will not suffer any noticeable fees.