A recent study by the National Institute on Retirement Security revealed some troubling statistics. The authors of the study conducted surveys with working-age Americans, asking them various questions on how secure they felt about retirement in general. Two of the most revealing findings:
- 56% of those polled were concerned about achieving financial security in retirement.
- 68% of those polled said that the vast majority of American workers cannot save enough on their own to achieve retirement security.
Even the most diligent savers get to retirement and wonder if their nest egg is enough to last them for the rest of their life. If you’re in this boat, know that you are not alone. We’ve written a number of posts on retirement because we want everyone to have the information they need to make a sound financial decision.
While 401(k)s and IRAs are commonly talked about, there are some other retirement options that also need to be discussed, including immediate annuities. This type of retirement investment, which offers a steady stream of income designed to last through retirement, can be complex. In this article, we’ll break down what you need to know about immediate annuities.
What is an immediate annuity?
Simply put, an immediate annuity is a contract between you and an annuity issuer, which is usually an insurance company. You agree to pay a single lump sum of money in exchange for the issuer's promise to make payments to you for a fixed time period or the rest of your life.
The annuity is considered “immediate” because you can start receiving your income within a year— or sooner— of purchasing the annuity. Deferred annuities, on the other hand, start paying out at a future date chosen by the annuity owner.
How does an immediate annuity work?
When you purchase an annuity, the issuer will take your lump sum and invest the money as they see fit. The interest and dividends earned on these investments will help provide the steady stream of income that the company has agreed to give you.
The amount of income you receive is based on a few factors, including your age at the time of purchase, your gender, whether payments will be made to only you or to you and another person, and whether payments will be made for a fixed period or until you die.
It will also depend on the type of immediate annuity you purchase. There are three main types to choose from:
- Fixed immediate annuities: This is the safest bet if you’re looking for a steady, fixed amount of money. With a fixed annuity, the issuer will pay a set amount of money, regardless of how the investments perform.
- Variable immediate annuities: Variable annuity payouts are tied to investment performance, meaning your income payments may increase or decrease regularly. If you can tolerate some fluctuations in your income, this may be a good option for you since market returns have historically exceeded those of safer investment vehicles.
- Index immediate annuities: Index annuities are a hybrid option between fixed and variable. Your income payments will be tied to a market index like the NASDAQ or S&P 500, but there will be caps on how much you can gain or lose. This makes it less volatile than variable immediate annuities.
In addition to which type of annuity you want, you’ll also need to decide on a payment option.
What are the payment options with an immediate annuity?
Most immediate annuities include a few payment options that can affect the amount of the payment you receive. The more common payment choices are:
Payment amounts are based on your age. Payments continue until you die, at which time they cease.
Installment Refund/Cash Refund
If you die prior to receiving at least the return of your investment in the immediate annuity, the beneficiary you name in the policy will receive an amount equal to the difference between what you invested and what you received. The beneficiary will receive this amount in either a lump sum (cash refund) or payments (installment refund).
Life with a Period Certain
With this option, the issuer does not guarantee the return of your investment; rather, it guarantees a minimum period of time during which payments will be made. Payments are made for the rest of your life, but if you die prior to the end of a minimum payment period (usually between 5 and 25 years), the payments will continue to be made to your beneficiary for the remainder of the period, but no longer.
Joint and Survivor
This option provides payments for the lives of two people, typically you and your spouse. When either of you dies, payments continue to be made for the life of the survivor. You can elect to have these "survivor" payments remain the same, or be reduced to a percentage of the original payment, such as two-thirds. The joint and survivor option can also be added to the life with period certain option. In this case, the issuer will make payments until both of you have died or for the period of time you selected—whichever is longer.
This option provides a guaranteed payment for the fixed period of time you specify (e.g., 5, 10, 15, 20 years). If you die before the end of the chosen period, your beneficiary will continue to receive payments for the remainder of the fixed period.
The payment option selected affects the amount of each payment. For example, life only payments will be larger than payments for life with a period certain. But life with a period certain payments will be less than payments for a fixed period certain.
Immediate Annuities: Pros and Cons
As with any financial investment, it’s important to be aware of the disadvantages that come with purchasing an annuity. Here’s how the pros and cons stack up against each other.
You can start getting money right away. If you’re nearing retirement or have already retired and want to secure your income starting now, immediate annuities offer payments starting almost immediately.
You’ll have to pay a lump sum upfront. The hardest part of purchasing an annuity is paying for it upfront. You’ll need to have a sizable amount saved up.
It can be a way to guarantee income for the rest of your life. If you aren’t sure if your retirement savings are enough to last you until you die, an annuity can offer peace of mind.
Additionally, if you opt-in for benefits after death, your heirs can continue to receive payments.
Getting your money out will be hard and come with a price. When you purchase an annuity, that money is no longer liquid. To withdraw money early, you’ll either have to break the contract or pay hefty fees— if you’re able to access the money at all. Consider if you’ll need a large sum of money before purchasing the annuity.
They are customizable. As you can see from the options we discussed above, there’s a good degree of customization that comes with annuities.
You may also be able to purchase riders, which are optional enhancements to your annuity. An example of this would be a cost-of-living adjustment rider, which adjusts your income as the cost of living increases each year.
You don’t have control over the investments. Once you purchase an annuity, you relinquish control of the funds. With other types of investments, you have hands-on control of where your money goes.
They can offer stability. If you choose a fixed or index annuity, you can rest assured that you’ll get a certain amount each month, regardless of how the investments perform.
Fixed immediate annuities won’t always grow with inflation. If you opt for the safer fixed annuity without cost-of-living adjustments, your payments will remain the same— even through periods of inflation. This means that the amount that you choose to receive today may not get you as far years down the line.
When should you consider an immediate annuity?
Overall, an immediate annuity can be a useful financial tool if:
- You want a stream of income that you cannot outlive.
- You have a sum of money that you would like to turn into a regular source of income and you aren't interested in leaving the money to your heirs. If you want to leave a portion of the money as a legacy, an immediate annuity may not be a good choice.
- You are uncomfortable with investments that have a significant risk of loss. If subjecting your money to the risk of loss associated with investing in securities does not appeal to you, an immediate annuity may provide a way to transfer that risk to an insurance company. While the income guaranteed by the immediate annuity is subject to the claims-paying ability of the annuity issuer, the immediate annuity payments are not subject to stock market risk.
- You expect to live for a long time. If you're healthy and have longevity in your family, an immediate annuity may be an investment to consider.
Other Factors to Consider
An immediate annuity can offer a measure of relief from retirement income concerns by providing a dependable payment for the rest of your life. However, as with most investments, there are other factors to consider before deciding if investing in an immediate annuity is the right choice for you.
First, be sure that the payment option you select will address your income needs. For instance, if you are in poor health and have others who depend on you for financial support, selecting a life only payment option may not be appropriate because payments stop at your death, which would remove a valuable source of income from your survivors.
Second, if you are considering a life only payment option, be aware that it may take many years before you receive at least the return of your investment from the immediate annuity.
Third, consider whether there are better alternatives for providing income. For example, the interest or dividend from investments such as bonds and dividend-producing stock could produce more income than you could get from an immediate annuity over the same period of time based on the same investment amount. Additionally, these types of investments usually are more liquid than immediate annuities, allowing you to increase your withdrawals if you need more money.
Retire with Peace of Mind
An immediate annuity is just one way to retire with the peace of mind that you’ll have enough money to meet your needs. It’s no small decision, so be sure to thoroughly research your options and consult with a financial advisor to make sure it’s the right choice for you.
* Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a registered broker-dealer Member FINRA/SIPC and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
Before deciding whether to retain assets in an employer-sponsored plan or rollover to an IRA an investor should consider various factors including but not limited to: investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Before you elect to open an IRA account and engage your investment representative, please review all account statements and disclosure documents related to the IRA and services to be provided under a new relationship and consult with a qualified tax advisor as needed. If transferring an existing retirement plan into an IRA, you should be aware that (i) Those assets will no longer be subject to the protections of ERISA (if applicable) (ii) depending on the investments and services selected for the IRA, you may pay more or less in transaction costs than when the assets are in the Plan, (iii) if you are between the age of 55 and 59 ½, you would lose the ability to potentially take penalty-free withdrawals from the plan, (iv) if you continue working past age 70 ½ and transferred your plan assets to a new employer’s plan, you would not be subject to required minimum distribution and (v) withdrawing assets directly would be subject to federal and applicable state and local taxes and possibly be subject to the IRS penalty of 10% if under age 59 ½.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.
Talk to a CFS Financial Advisor
Want to take your retirement plans to the next level? Schedule an Amplify Wealth Management appointment with our colleagues at CUSO Financial Services (CFS).