Understanding Immediate Payment Annuities
Let me explain what an immediate payment annuity is—it's a contract you make with an insurance company where you hand over a lump sum, and in return, you get guaranteed income payments that kick in right away.
This setup stands apart from a deferred annuity, where payments don't start until some future date you pick. You might hear it called a single-premium immediate annuity (SPIA), an income annuity, or just an immediate annuity.
Key Aspects You Should Know
Insurance companies sell these immediate payment annuities, and they can start providing income to you almost right after you buy one. You get to choose how often you receive the money—monthly, quarterly, or annually works.
Most of the time, the payments stay fixed throughout the contract term, but you can also find variable options that change based on investment performance, or ones that adjust for inflation to keep up with rising costs.
How an Immediate Payment Annuity Operates
You typically purchase one by giving an insurance company a lump sum of money. They then commit to paying you a regular income based on the contract terms. The insurer figures out your payment amount using factors like your age, current interest rates, and how long the payments will last.
Payments usually begin within a month of your purchase. You decide the payment frequency, or mode—monthly is the most popular, but quarterly or annual options are available too.
Many people use these to boost their retirement income, like adding to Social Security, and set it up to last their lifetime. You can also opt for a shorter period, say five or 10 years.
Generally, the payments are fixed, but some companies offer variable versions tied to a portfolio of securities, or inflation-protected ones that increase with inflation.
The Gamble Involved
Here's an important point: immediate payment annuities involve some risk. If you die sooner than expected, you might not get full value from your money, but if you live longer, you could end up ahead.
Special Considerations to Keep in Mind
One downside is that payments usually stop when you die, and the insurance company keeps what's left. That means an early death could mean not getting your money's worth, while living long pays off.
You can address this by adding a second person to the contract for a joint and survivor annuity, or choosing one that guarantees payments to beneficiaries for a set time, or even a cash refund if you die early. These extras cost more, though.
Once you buy it, you can't cancel for a refund, which could be an issue in a financial emergency. That's why I recommend having an emergency fund ready before deciding how much to put into the annuity.
What Exactly Is an Immediate Annuity?
It's called immediate because payments from the insurance company start quickly. You pay them a sum, and they give you income, often for life.
What's the Downside?
High fees and low liquidity are common issues, reducing your income and making it hard to access funds quickly. Many contracts have surrender fees if you try to cancel early.
Do You Pay Taxes on It?
Yes, withdrawals from an immediate annuity are taxed as income at your bracket rate. There are qualified annuities funded with pretax dollars, where the whole withdrawal is taxed, and nonqualified ones with after-tax dollars, where only earnings are taxed.
Can You Cash It Out?
Usually, you can't without facing big surrender fees. Annuities aren't very liquid, which is a notable drawback.
The Bottom Line
With an immediate payment annuity, you pay the insurer upfront and start getting income soon after, at intervals you choose from monthly to annual. Unlike a deferred annuity, it doesn't wait for a future date to begin payments.
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