Immediate Annuities Explained

Immediate annuities turn a lump sum into an income stream. The income stream you receive depends on the type of immediate annuity you purchase.

There are three main decisions you need to make when choosing an immediate annuity.
  • How long do you want your annuity to last? Your lifetime, or for a fixed amount of time, say 20 years?
  • At the end of your life would you like the annuity payments to end also, or would you prefer the annuity to continue and provide income to your spouse?
  • Would you like the income from your annuity to be guaranteed not to fall below a certain miniumum level, or are you willing to have its performance linked to the ups and downs of the stock market?
Let's address each of these questions in turn.

How Long Would You Like The Income To Last?

You can choose whether the annuity income should stop after a chosen number of years or stop at the end of your lifetime. The longer the annuity has to pay you an income for, the lower your interest rate will be. Your age will be taken into account in the interest rate you receive. The older you are or the lower your life expectancy, the higher the interest rate you receive will be.

Term Certain Annuities
In a term certain contract, you specify the number of years you will receive an income for. The shorter the time span, the higher the monthly payments you receive will be. If you die during the stated period, your heir(s) will continue to receive the payments.

A term certain annuity can be useful to bridge an income gap - for example, if you stop work at 60 but your pension isn't due to be paid for some years. There are legal limits on how many years a term certain annuity can cover.

Single Life Annuities
If you opt for single life annuity payments, these will continue until your life comes to an end. If you begin receiving payments at the age of 60, even if you lived to be 120 years old, your payments would not stop; they would continue for the whole 60 years.

If, however, you live only to the age of 61, all of your annuity income stops after one year. Your spouse gets nothing from the annuity. In these circumstances your annuity will have been a poor purchase.

If you live to be 90, your payments will continue for 30 years. 30 years is a long time in the commercial world. Companies come and go in this time frame. Make sure you buy an annuity from a company you believe will stand the test of time.

An Income For Your Spouse After Your Demise

Joint life annuities address the issue of a couple requiring an income until the demise of both partners.

Joint Life Annuities
Joint life payments are paid while one person from a couple continues to live. If you opt for a joint life annuity, your monthly checks will be lower than for a single life annuity. (There's no such thing as a free lunch. It's likely more checks will have to be paid by the insurance company for a joint life than for a single life annuity.) One way for a couple to get a higher payment is to choose a plan that, after the demise of one partner, pays a reduced income - say 75% or 50% of the original payment - to the surviving partner.

Fixed, Variable or Equity Indexed Annuity?

Fixed Annuities
Although they are called fixed, some fixed annuities don't actually offer you a fixed interest rate. Instead they offer you a guaranteed minimum interest rate of say 4.0 percent and a better introductory interest rate in your annuity's first year. The interest rate can move up or down but will never go below your minimum guaranteed rate. The fact that there is a floor on payments can be a useful tool in planning your retirement income.

The fixed nature of the payments can, however, be a disadvantage if the purchasing power of your annuity payments are eroded by inflation. To counter the effects of inflation, annuities are available that will pay you a growing income each year - growing by 3 percent or 5 percent - but this type of annuity pays a lower initial return.

Returns from fixed annuities depend on the general level of interest rates in the economy. When interest rates are low, returns from fixed annuities are also quite low. To obtain a comfortable income in these circumstances, you will need to invest quite a large lump sum in your annuity.

For example, a return of 4.2% provides a gross income of $350 a month for each $100,000 of lump sum you invest. For a gross income of $1,750 a month you'd need to spend $500,000 on your annuity.

Variable or Equity Indexed Annuities
If you are willing to sacrifice the security of a minimum guaranteed income, variable and equity indexed annuities offer the possibility of better returns. Investors in the early years of the 21st century, however, have grown increasingly sceptical of the ability of stock-linked annuities to provide a reliable retirement income.