For most people, having a source of regular income is a necessity. An immediate annuity is a financial service that provides a consistent and predictable flow of incoming funds. Essentially, the beneficiary provides a lump sum payment to the company and, in exchange, receives an agreed-upon amount every year. While an immediate annuity could help maintain cash flow, it also isn’t right for everyone.
How an Immediate Annuity Works
With any form of an annuity, you are essentially purchasing insurance that provides a known outcome. It isn’t an investment, even though they can earn a return. Instead, the primary purpose of an annuity is to give the beneficiary a guaranteed amount of money every year for the remainder of their lives or a set number of years.
An immediate annuity involves entering into a contract with an insurance company. The insurer receives a lump sum upfront. Then, the recipient receives annual payments every year.
A few factors impact how much the beneficiary receives. For example, the kind of annuity affects the annual payment, as fixed, variable, and inflation-indexed immediate annuities are all calculated differently.
Fixed vs. Variable
Fixed annuities come with a set payment every year. Variable versions may have a guaranteed minimum payout, but it can also be tied to a specific stock market index, causing the payments to fluctuate based on market performance. Inflation-indexed immediate annuities start with smaller annual payments, though the payout rises over time to account for inflation.
The recipient’s age and the term they select also play a role. When you choose a term, you are dictating how long the annuity needs to last, whether that be a specific number of years or the rest of a person’s life, regardless of how long that will be. The recipient’s age helps the insurer estimate the person’s remaining lifespan, allowing them to calculate a yearly payment amount.
Is an Immediate Annuity Right for You (or Your Loved One)?
In most cases, an immediate annuity is a source of income for retirees or any individual who does not have a steady influx of cash due to an inability to work, such as someone with a serious disability. However, based on how the arrangement functions, younger people with longer anticipated lifespans usually don’t want to go this route even if they can’t work anymore. Since the annual payment is calculated based on how much longer the company believes the person will live (unless you use a term for only a set number of years), the yearly income may be so small that it doesn’t make sense to pursue an annuity.
Opting for an immediate annuity over other options for generating long-term income can be beneficial to some people. First, an annuity comes with a guarantee; you know exactly how much you will receive and for how long, and that provides a level of financial security. If other sources of guaranteed income (like a Social Security or pension payments) cover less than 50 percent of your expenses, then an annuity could be a smart move.
Second, healthy retirees who could outlive other forms of retirement savings may benefit from an annuity. Since life-long terms are available, an annuity prevents one source of income from running out over time. Finally, an annuity can make it harder to over-spend early in one’s retirement. Since you only receive a set amount, you can’t spend more of your annuity until the next payment arrives. If someone is concerned about making poor financial decisions should their cognitive abilities decline with age, this acts as a level of protection.
However, to start an immediate annuity, you do need a large lump sum, and that isn’t practical for everyone. Plus, the setup fees can be high, eating into that initial lump sum.
Additionally, if the recipient passes away, the benefit may expire depending on the exact terms of the arrangement. If the beneficiary is in poor health, then a significant amount of money may never be paid out, and there might not be any way for families to get it back.
Can You Get a Refund on an Immediate Annuity?
Once you sign up for an immediate annuity, changing your mind isn’t an option. Once the contract is in place, that’s it. You can’t renegotiate or ask for your money back. They also cannot be canceled for a prorated amount.
Your only alternative at that point is to use a company that provides lump-sum payments in exchange for becoming the beneficiary of the annuity. You won’t get near the full value of the remaining annuity in these arrangements, so it is important to understand that a loss is pretty much a guarantee when going this route.
Do you have (or know anyone with) an immediate annuity? Tell us about it in the comments below.
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