An immediate annuity is an insurance product that provides guaranteed income: you give an insurer a sum of money and the company provides you with a stream of payments that can last for a lifetime. Payments begin within 12 months of purchase.
Now may be a good time for retirees to buy an immediate annuity, since payouts are the highest they’ve been in a decade, says Rob Williams, managing director of wealth management at Charles Schwab.
But purchasing an immediate annuity, also known as an income annuity or immediate fixed annuity, is effectively irreversible, so you’ll want to choose carefully.
WHY YOU MIGHT CONSIDER AN IMMEDIATE ANNUITY
One of the big risks of retirement is outliving your savings. Having enough guaranteed income to cover basic expenses can give you the peace of mind that you’ll have a roof over your head and food in the fridge, no matter what.
A major source of guaranteed income is Social Security, and some people still benefit from traditional pensions. If you don’t have enough guaranteed income to cover essential living costs, however, an immediate annuity could fill the gap, says Wade Pfau, author of “Retirement Planning Guidebook.”
But immediate annuities shouldn’t be an all-or-nothing solution, Pfau says. Ideally, you would also have money invested in stocks for growth, as well as cash reserves for emergencies.
Immediate annuities can help you get out of bear markets, notes Williams. The steady stream of income could help you avoid selling investments to meet living expenses, she says.
HOW MUCH YOU CAN GET FROM AN IMMEDIATE ANNUITY
There are many types of annuities, and some are incredibly complex. In contrast, immediate annuities are relatively simple: Your payout depends largely on how much you invest, your age, prevailing interest rates, and the payment option you choose.
For example, a 65-year-old man and woman who invest $100,000 can expect a monthly check of about $535 if they choose the joint living option, where the payment continues for both lives, according to the estimated annuity income of Charles Schwab. If they choose a cash repayment option, the monthly check drops to about $532, but their heirs will receive the remaining money if the couple dies before recouping their original investment.
This is a relatively cheap form of insurance and could reassure people who fear the insurance company will “win” if they die prematurely, Williams says.
Payments also depend on the insurer. According to online marketplace ImmediateAnnuities.com, monthly allowances for the couple could range from $513 to $565 per month for the joint living option, depending on the company.
Some companies sell annuities with cost-of-living adjustments in each subsequent year, but the initial payments are much lower. For our hypothetical couple, a 3% annual inflation adjustment would result in payments ranging from $359 to $379 to start, according to ImmediateAnnuities.com.
Inflation protection may not be needed if retirees have Social Security, which is adjusted for inflation, and stock investments, which provide above-inflation returns over time, Pfau says.
PAY ATTENTION TO THE INSURER’S ASSESSMENTS
Since payments vary, you would do well to shop around, but also consider the insurance company’s rating. A financially weak company may not be able to provide promised payments. (Schwab’s online marketplace represents insurers rated A+ or better by Standard and Poor’s, while ImmediateAnnuities.com includes companies rated A- or better by AM Best.)
Your state’s guaranty association protects your annuity up to certain limits if your insurer goes bankrupt. In California, for example, the association covers 80% of the value of the annuity up to $250,000, but the maximum coverage available per individual is $300,000.
If you want to invest more than the state coverage limit, consider purchasing from several companies so that all your eggs aren’t in one insurer’s basket, Williams says. You can also “scale” your purchases by purchasing immediate annuities every year or every few years. Annuity payments are tied to the yield of highly rated corporate bonds, so laddering allows you to take advantage of higher payments on newly purchased annuities if bond yields rise, although payments could shrink if bond yields fall, he notes.
How your payments are taxed depends on where you got the money to buy the annuity. If the money comes from an after-tax account, such as a savings or brokerage account, a portion of each payment will be considered a return on your investment and will not be taxed.
If you’re purchasing the annuity with money in a qualified retirement account, such as an IRA or 401(k), the payments generally will be taxable, but so will any withdrawals from that source. Money used to purchase an immediate annuity will not be considered part of retirement funds when it comes time to calculate required minimum distributions, which usually must start at 73. This could be a boon for large savers who are worried that such distributions will push into a higher tax bracket.
Immediate annuities aren’t a solution for every retiree, but they can be an effective way to buy peace of mind, Williams says.
“Generating income on your own can be daunting, and annuities are a good tool to help,” he says.
_______________________________
This article was provided to the Associated Press by the personal finance site NerdWallet. The content is for educational and informational purposes and does not constitute investment advice. Liz Weston is a columnist at NerdWallet, a certified financial planner, and the author of “Your Credit Score.” Email: lweston@nerdwallet.com. Twitter: @lizweston.
RELATED LINK:
NerdWallet: How Long Will My Money Last in Retirement? Calculator, how to stretch it https://bit.ly/nerdwallet-how-long-will-your-retirement-money-last