Question: Why would anyone buy an immediate annuity? What’s the purpose of it? Isn’t it just getting your money back? from Taylor G. in Los Gatos, California
Answer: Interesting questions Taylor, but very good ones. An immediate annuity is formally called a Single Premium Immediate Annuity, and also known as an income annuity. It is the original annuity product and was first introduced in Roman times.
People buy immediate annuities because they are looking for a pension type income stream. They want to make sure that they are not going to outlive their money (aka: longevity risk), regardless of how long they live. That is the true purpose of an immediate annuity.
An immediate annuity is a pure transfer of risk product. You are transferring the risk to the insurance company to guarantee paying you for as long as you live. In essence, you are making a bet with the insurance company/annuity carrier that you are going to live longer than they think you are going to live. And if you do live longer than your proposed life expectancy, they are on the hook to pay you. It’s important to know that all annuity income streams are based on your life expectancy at the time you decide to take income.
You can also set up an immediate annuity to pay for a certain period of time. For example, you can buy a 10 Year Certain Immediate Annuity. That means there will be 10 years of payments going to you, or your listed beneficiaries if you die before the 10 year time period is up. After the 10 years of payments, then the policy is over and done. These “period certain” immediate annuities are not currently used that much due to the low interest rate environment.
You can combine a period certain with a life guarantee. For example, you can buy a “Life with 10 year certain” immediate annuity. That means the annuity will pay you for life (regardless of how long you live), or 10 years….whichever is longer. For instance, if you live till you are 125, it will pay you. But if you die 2 years after the annuity has been issued, then your listed beneficiaries will receive 8 more years of payments (8 + 2 = 10).
An immediate annuity payment is a combination of return of principal and interest. So part of your question is correct, you are getting some of your money back. Outside of an IRA (or in a non-qualified account), your income stream will have tax benefits because you will not pay taxes on the principal, but only the interest.
One of the fallacies about an immediate annuity is that if you die, the insurance company keeps the money that has not been used. That’s called a “Life Only” annuity, and if you structure it like that, then that example could happen. However, you can structure the policy so that the insurance company will never get a penny, and if you die early in the contract, 100% of the unused money will go to your listed beneficiaries.
And finally, an immediate annuity is a true commodity product. It pays the lowest commission to the agent. Simple. Efficient. No Fees. Pure transfer of risk. There are about 50 to 60 companies that are truly competitive in the immediate annuity world, so my advice is to shop them all for the best and highest contractual guarantee.
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