What is an immediate annuity & how does it work?

The bottom line:

Immediate annuities can provide you with a steady income stream in retirement.

Withdrawals begin immediate or within the first year after your purchase.

Match your tolerance for risk by choosing a fixed or variable annuity.

An immediate annuity, also referred to as a single payment immediate annuity (SPIA), is an insurance contract funded by a lump sum payment, such as money from a savings account, a 401(k) or an individual retirement account (IRA). You decide on the frequency and duration of your payouts when you buy it. Your initial withdrawal can start in as early as 30 days but must be taken within the first year. A possible consideration for people with little or no pension income, an immediate annuity can provide you with a steady income stream during retirement.

An immediate annuity can help bridge the gap between retiring and claiming your Social Security benefits without liquidating your retirement savings accounts.

Without a pension plan from your employer to provide consistent income (which is becoming increasingly rare these days), your options may include taking out cash from your 401(k) or IRA to cover your expenses. But if you withdraw your money from these accounts too quickly, you risk outliving your savings. Withdraw it too conservatively and it may not be enough to cover your monthly expenses.

Guaranteed income from your immediate annuity can be used to help cover essential expenses like groceries, insurance, utilities and other monthly bills. The money you’ve saved in your other retirement accounts can be used on non-essential spending, like vacations and family travel.

Immediate annuities are an option if you're close to retirement and need a steady income.

• Payouts can begin immediately. Payments start one month after your annuity is issued or can be delayed up to a year.
• Payments remain consistent. Consistent payouts mean you are less likely to outlive your retirement savings.
• Potential for tax savings. Your annuity continues to defer taxes. Only the annuity payments you receive in that year are taxable.
• Can be set up as a joint annuity. Payouts can continue as long as you and your spouse or partner live.
• They're easy to manage. Once you purchase an immediate annuity, there are no additional steps and nothing to monitor.
• Flexible payout options. Flexibility of payouts is one of the advantages an immediate annuity offers. You can decide between level payments, fixed percentage increases, or increases tied to the rate of inflation.

While immediate annuities have several advantages, they’re not suitable for everyone. These types of annuities are typically not designed for people looking for increased wealth or capital appreciation. Plus, when you die, payments can stop, leaving nothing for your heirs.

• Reduces cash liquidity. When you purchase an annuity, you lose immediate access to that money. If you need it soon, it won’t be available—at least without a sizable penalty.
• No accumulation phase. Since you start receiving payments immediately, there is no accumulation phase and therefore less growth potential.
• Leave a smaller inheritance. Unless you have selected a specific amount of time to receive payments, when you pass away the balance of your annuity will go to the insurance company's general account. It will not go to your heirs.
• Higher upfront costs. Immediate annuities are purchased with a large, upfront deposit of cash.

While there are many optional features in an immediate annuity, it will only grow income in two ways—through interest rates as a fixed annuity or by investing your money in the market as a variable annuity.

In exchange for your lump-sum payment, the annuity provider agrees to pay you a consistent, set income for life or a specified term. The fixed interest rate removes any risk associated with market ups and downs. It allows you to receive a consistent income stream through retirement.

Read more: What is a fixed annuity?

Variable immediate annuities are held in subaccounts and are dependent on market risk and performance. You choose to invest in subaccounts tied to assets like stocks, bonds, and money market funds. If the investments do well, your payout increases.

But on the same note, if the investments perform poorly, your payments may decrease, like regular investment accounts. An immediate variable annuity may be a great addition to your retirement income plan if you've already maxed out your Roth IRA or 401(k). So you can focus on your goals, knowing you won't outlive your money. Thrivent does not currently offer variable immediate annuities.

Read more: What is a variable annuity?

After you pay the premium, a guaranteed stream of income (annuity payments) will begin based on the type of annuity payments you choose. The available options include the following:

• Fixed period. Lasts for a set period, such as 15 or 25 years, instead of a lifetime. Also referred to as period-certain or term-certain payout options.
• Life-only. Decline to pass leftover money onto a beneficiary when you die. Potentially receive higher monthly income payouts in exchange. (This is different from other types of payout options which allow you to pass on remaining funds.)
• Single-life vs. joint-and-survivor. "Single-life" is another way of saying "life-only" payout option. (Defined above.) A joint-and-survivor payout allows you to pass on remaining funds to a beneficiary.
• 50% joint-and-survivor. Are your annuity income payouts shared by two people? If so, this type of payout option will pay half after one person dies.
  

Read more: The 4 types of annuities: Which is right for you?

The terms "deferred" and "immediate" refer to when the actual distribution of your annuity begins. A deferred annuity is funded with a lump sum or payments over time (called an accumulation period). Payout starts on a future date. An immediate annuity starts paying when you deposit a lump sum or in the first 12 months following its purchase.

Read more: What is a deferred annuity?

You may want to consider an immediate annuity if you fall into one of these scenarios:

• You're entering retirement soon and need a secure way to generate income when retired. Payments begin right away, and it’s one way of turning savings into income for the rest of your life.
• You're looking for a secure way to generate income in retirement.

To learn more about how immediate annuities can help you reach your retirement goals, connect with a financial advisor near you.