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Immediate annuities are the simplest type of annuities. You give the insurance company a sum of money, called the premium, and they give you a payout each month for the rest of your life.
It could be said that the insurance company is betting that you will die sooner, since at that time the payouts stop. You, on the other hand, are betting that you will receive payments over the entire payout period or live out a very long life if you purchased a lifetime policy.
These annuities are mostly sold to retired people who will have sufficient assets remaining after purchasing the annuity to cover unexpected emergencies. Immediate annuities provide a guaranteed lifetime income stream, and there is no provision for a lump-sum payout to cover emergencies.
You give the insurance company a lump sum of money, called the premium. In return, the insurance company agrees to provide income payments according to the terms of the annuity contract.
The payout amount is based on your age, life expectancy, premium amount, and selected payout structure. A lifetime policy may pay for as long as you live, while a fixed period option may pay for a selected number of years.
Because immediate annuities usually do not provide a lump-sum payout for emergencies, they are often used by retirees who still have other assets available for unexpected needs.
This is only an example and does not represent an actual scenario. To see how immediate annuities work and determine if they are a good option, consider this example.
If you are a male, 65 years old in 2013 living in Texas, then for a $100,000 premium, you could purchase an immediate annuity providing a lifetime monthly income payment of $585. The payout of 7.02% is determined by the yearly payout of $7,020 for the $100,000 premium.
What interest rate are you earning on your investment? That depends on when you die.
If you live about 14 more years until age 79, then you will have just received back your entire $100,000 premium. In that case, you will have realized a 0% interest rate.
Your life expectancy, if you are 65, is about 19 years, so on average you should live until age 84. If you make it that far, you will have received $133,380, which is equivalent to having received an annual interest rate of 3.182% on your investment for the 19 years.
You can think about this return in more familiar terms. Assume you borrowed $100,000 and had to pay back $585 per month. If the contract called for 14 years of payment, then you would pay back the original amount, meaning the loan would have had zero annual interest.
If it took longer to pay off the loan, then that would mean interest was applied. If the yearly interest rate were 3.182%, then it would take 19 years to pay off the loan, and the total payments would be $133,380.
Now reverse the thinking and realize that the insurance company has effectively borrowed the $100,000 from you and is paying it back with an effective interest based on how long you live.
To get the 7.02% annual interest advertised, you would have to live a very long time, more than another 100 years. However, if you made it to your life expectancy of age 84, the annual return would be approximately 3.2%.
Some plans can continue payments if you die early. One example is a policy that pays for 20 years either to you if alive or to a beneficiary after you die.
In that example, the payments, instead of being $585, would be reduced to $508 per month. At the end of the 20 years when payments stop, the effective annual interest rate would be 2.0% instead of 3.6% from the table.
Please give us a call if you would like help understanding whether an immediate annuity may fit your retirement income plan.
An immediate annuity is an annuity where you give the insurance company a premium, usually a lump sum, and the company provides income payments according to the contract terms.
Immediate annuities are often used by retirees who want a guaranteed income stream and still have enough remaining assets to cover unexpected emergencies.
The insurance company calculates the payout based on factors such as your age, life expectancy, premium amount, and the payout option selected.
Yes. Some immediate annuities can be structured to provide payments for the rest of your life, while others may pay for a fixed period such as 10, 15, or 20 years.
Immediate annuities generally provide income payments and usually do not include a lump-sum payout option for emergencies. That is why other emergency assets are important.
It depends on the payout option selected. Some plans may stop payments at death, while others may continue payments to a beneficiary for a guaranteed period.
Not necessarily. The effective return depends on how long payments are received. If you live longer, the total amount paid back may be higher.
Yes. Immediate annuities can affect your retirement income and liquidity, so it is helpful to review your full financial picture before purchasing.
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