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.

As you near retirement, you may be thinking about how to make the savings that you’ve accrued in your retirement accounts last a lifetime. An immediate annuity may be a smart option to consider. They can provide a source of guaranteed income by preserving the principal of a large lump-sum investment and turning it into a guaranteed income stream.

In this article, we’ll cover:

• What is an immediate annuity?
• How can an immediate annuity help fund your retirement?
• The difference between immediate & deferred annuities
• What are the benefits of an immediate annuity?
• What are the drawbacks of an immediate annuity?
• Types of immediate annuities
• Payout options for immediate annuities

An immediate annuity, also referred to as a single premium immediate annuity (SPIA), is an insurance contract funded by a lump-sum payment, such as money from 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.

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.

The terms "deferred" and "immediate" refer to when your annuity distribution begins. Deciding on an immediate annuity versus a deferred annuity depends on your retirement goals.

• You fund a deferred annuity with a lump sum or payments over time. Funds accumulate over time and your payout starts on a future date.
• Immediate annuity payments begin within 12 months after depositing a lump sum.

Read more: What is a deferred annuity & how does it work?

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

• Immediate payouts. Payments can start as early as one month after your annuity purchase or can be delayed up to a year.
• Consistent payments. Receiving regular payouts means you're less likely to outlive your retirement savings.
• Potential for tax savings. Only the annuity payments you receive in that year are taxable.
• They can be set up jointly. With a joint-and-survivor annuity, payouts may continue throughout both of your lives.
• They are easy to manage. Once you purchase an immediate annuity, you don't have additional steps or anything to monitor.
• You have flexible payout options. 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. Immediate annuities are not designed for people looking for increased wealth or capital appreciation.
• Leave a smaller inheritance. Unless you've selected a specific amount of time to receive payments, your annuity balance goes to the insurance company's general account when you pass away. It doesn't go to your beneficiaries.
• Higher upfront costs. Immediate annuities are purchased with a large, lump-sum deposit of cash.

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

Annuities can be a great addition to your retirement income plan, as they are one of the few investment solutions that can ensure you won't outlive your money. Get a refresher on the four main types of annuities and their features.

See the options

While there are many optional features in an immediate annuity, it only will 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 & how does it work?

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 & how does it work?

After you pay the premium, you receive a set stream of annuity payments. But the annuity payout option you choose affects when those payments begin and how long they last. The available options include:

• Fixed period. Fixed-period payments last for a set period, such as 15 or 25 years, instead of a lifetime. They're also referred to as period-certain or term-certain payout options.

• Life-only. Life-only payouts don't pass leftover money to a beneficiary when you die. You can potentially receive higher monthly income payouts in exchange. (This is different from other payout options, which allow you to pass on the remaining funds.)

• Single-life vs. joint-and-survivor. "Single-life" is another term for a "life-only" payout option. A joint-and-survivor payout allows you to pass on the remaining funds to a beneficiary.

• 50% joint-and-survivor. If two people share your annuity income payouts, this payout option pays half after one person dies.
  

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 you're 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.