An immediate annuity is an insurance product that provides guaranteed income: You give an insurer a chunk of money, and the company gives you a stream of payments that can last for life. The 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 buying an immediate annuity — also known as an income annuity or a fixed immediate annuity — is effectively irreversible, so you’ll want to choose carefully.
WHY YOU MIGHT WANT TO CONSIDER AN IMMEDIATE ANNUITY
One of the big risks in retirement is outliving your savings. Having enough guaranteed income to cover basic expenses can give you assurance that you’ll keep 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 have traditional pensions. If you don’t have enough guaranteed income to cover essential living costs, though, an immediate annuity could fill in 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 also would have money invested in stocks for growth, as well as cash reserves for emergencies.
Immediate annuities can help you ride out down markets, Williams notes. The steady stream of income could help you avoid selling investments to meet living expenses, he says.
HOW MUCH YOU CAN GET FROM AN IMMEDIATE ANNUITY
There are many types of annuities, and some are mind-bendingly complex. By contrast, immediate annuities are relatively straightforward: Your payout depends largely on how much you invest, your age, prevailing interest rates and the payout option you choose.
For example, a man and woman age 65 who invest $100,000 can expect a monthly check of about $535 if they choose the joint life option, where the payment continues for both lifetimes, according to Charles Schwab’s annuity income estimator. If they choose a cash refund option, the monthly check drops to about $532, but their heirs will receive any money left over if the couple dies before getting back their original investment.
That’s a relatively cheap form of insurance and could provide some reassurance to people who worry the insurance company will “win” if they die early, Williams says.
Payouts also depend on the insurer. According to the online marketplace ImmediateAnnuities.com, monthly checks for the couple could range from $513 to $565 a month for the joint life option, depending on the company.
Some companies sell annuities with cost-of-living adjustments in each subsequent year, but initial payouts are much smaller. For our hypothetical couple, a 3% annual inflation adjustment would result in payouts ranging from $359 to $379 to start, according to ImmediateAnnuities.com.
Inflation protection may be unnecessary if retirees have Social Security, which is inflation-adjusted, and investments in stocks, which deliver inflation-beating returns over time, Pfau says.
PAY ATTENTION TO INSURER RATINGS
Because payouts vary, you’d be smart to shop around — but also consider the insurance company’s rating. A financially weak company may not be around to deliver the promised payouts. (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 fails. In California, for example, the association covers 80% of annuity value 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 buying from different companies so all your eggs aren’t in a single insurer’s basket, Williams says. You can also “ladder” your purchases by buying immediate annuities every year or every few years. Annuity payouts are linked to the yield on highly rated corporate bonds, so laddering allows you to take advantage of higher payouts on newly purchased annuities if bond yields rise — although payouts could shrink if bond yields fall, he notes.
How your payouts are taxed depends on where you got the money to buy the annuity. If the cash came from an after-tax account, such as a savings or brokerage account, a portion of each payment will be considered a return of your investment and won’t be taxed.
If you’re buying the annuity with money in a qualified retirement account, such as an IRA or 401(k), the payouts typically will be taxable — but so would any withdrawal from such a source. The money used to buy an immediate annuity won’t be considered part of your retirement funds when it’s time to calculate required minimum distributions, which usually must begin at 73. That could be a boon for big savers who are worried about such distributions pushing them 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.
