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The benefits & drawbacks of immediate annuities

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Vladimir Vladimirov/Getty Images

As retirement approaches, it's satisfying to know you've worked hard and are ready to enjoy the fruits of your labor. But it's also natural to wonder if you'll have enough money to last for the rest of your life. Will your savings, Social Security and any pension you have be enough? It's possible that an annuity can help alleviate your concerns.

Paid with an upfront, lump-sum premium, an immediate annuity quickly converts into a steady stream of income you can use to complement your other retirement funds. That makes the benefits of an immediate annuity worth considering as you near retirement age.

What is an immediate annuity?

An immediate annuity, sometimes called a single premium immediate annuity, or SPIA, is an insurance contract that can guarantee a secure source of income throughout your retirement years. After funding it with a lump sum, you can begin taking regular payouts as early as 30 days from purchase. These payments can last either for a defined period (up to 30 years) or as long as you live, depending on the payout option you choose.

Unlike deferred annuities, which people often purchase earlier in life, immediate annuities don't have accumulation phases. This gives them less growth potential. However, you can lock in how much cash you'll receive, how frequently your payouts will arrive and how long they'll continue. The simplicity and predictability of immediate annuities can be beneficial for anyone who is imminently approaching or already in retirement.

Benefits of an immediate annuity

Understanding immediate annuity pros and cons can help you determine whether this tool could meet your needs. Here's a look at some of the advantages:

You can lock in income for as long as you choose

Flexibility is one of the biggest advantages of an immediate annuity, because you decide how long you’ll receive income. You might elect to only receive income for a limited period—perhaps to cover the gap between when you stop working and when you begin taking Social Security. Alternatively, you may choose to guarantee payments through the rest of your life and your spouse or partner's life.

Options include:

  • Single-life income: Payments for the rest of your life.
  • Joint-life income: Payments for the rest of your life and your spouse's life.
  • Fixed-period: Payments for a certain number of years.
  • Specified amount: Payments of a certain dollar amount that stop when the contract is depleted.

You choose your payment amounts

An immediate annuity allows you to tailor your payments to meet your needs. You set the starting amount of your annuity's income payments and choose:

  • A level amount. Your payments remain the same throughout the entire payment period. This may be appropriate if you want to rely on receiving the same payment amount every year.
  • A fixed-percentage increase. You choose an annual increase each year, such as between 1% and 5%. This may be appropriate if you want your payments to increase and prefer to know exactly what they will be in the future.
  • Inflation-adjusted. If the consumer price index is positive, payments will adjust upward to a cap. This may be best if you are concerned about inflation risk to your retirement savings.

You can start to receive income right away

An immediate annuity can start issuing payments to you as soon as 30 days after your purchase date. If you prefer, you can put off the first payment for up to one year. If you like the idea of an annuity but want income payments to begin later, consider exploring a deferred annuity instead.

They’re easy to manage

The contract terms for an immediate annuity, including your premium cost and your income payout amounts, are decided from the start. So, there's no need for account monitoring and management. That means that immediate annuities typically don’t have any account management or maintenance charges.

A death benefit can extend payments to your heirs

Most immediate annuities give you the opportunity to include a death benefit in your contract. If you opt for a guaranteed payment period and pass away before it concludes, your beneficiaries will receive the remainder of your scheduled payouts. If you're concerned about supporting your family after your death, this might be a reliable way to ensure their care after you're gone.

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Considering a different type of annuity?

Get a refresher on the four main types to get a sense if one is right for you.

See the options

Possible drawbacks of an immediate annuity

Immediate annuities may not be right for everyone. Here are some of the potential cons of an immediate annuity:

You need access to a lump sum of money

Typically, you purchase an immediate annuity with a single, large premium payment. People often tap savings accounts, 401(k)s or IRAs for this purpose. If you don't have those resources or prefer to use them for other purposes, it may be difficult to fund an immediate annuity.

Reduction of liquidity

Once you fund your annuity, you don't have easy access to that lump sum. If you wish to retrieve any of the money beyond your prearranged income payments, you'll likely pay a high financial penalty and reduce future income.

Limited potential for growth

An immediate annuity begins distributing income payments shortly after you fund it, so there's little time for earnings to accumulate. With a fixed immediate annuity, growth that does occur is based on a set interest rate, so you may miss opportunities to achieve higher earnings.

Potential impact of inflation

Opting for level, unchanging payments for the entire duration of an immediate annuity may mean the income payments you get later in the contract don't stretch as far as they once did if inflation has risen. Some immediate annuities, however, offer a provision that adjusts based on inflation so that your money retains the same buying power over time.

Should you buy an immediate annuity?

If you're nearing retirement and don't have a pension or are worried that Social Security checks won't cover your living expenses, an immediate annuity may be a good way to guarantee you have money coming in to meet your daily needs. However, if you don't need additional income in the near future or you want to use your existing savings to build an inheritance for loved ones, you might prefer to focus on investments that provide opportunities for greater financial gains.

Consider meeting with a Thrivent financial advisor to discuss if an immediate annuity aligns with your overall financial plans.

Withdrawals and surrenders will decrease the value of your annuity and, subsequently, the income you receive. Any withdrawals in excess of 10% may be subject to a surrender charge. The taxable portion of each annuity distribution is subject to income taxation. If a taxpayer is younger than 59½ at the time of distribution, a 10% federal tax penalty will apply to the taxable portion of the distribution unless a penalty-tax exception applies.

Guarantees based on the financial strength and claims paying ability of Thrivent.

Holding an annuity inside a tax-qualified plan does not provide any additional tax benefits.

Thrivent and its financial professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Thrivent financial advisors and professionals have general knowledge of the Social Security tenets. For complete details on your situation, contact the Social Security Administration.