Now that the majority of employees can no longer look forward to a gold watch and company pension at retirement, most now will be depending on 401(k) plans to fund their retirement years. Upon retirement, there are a number of options available when the time comes to start tapping a 401(k): a lump sum distribution, periodic distributions, or a rollover to an IRA.
There can be advantages to choosing periodic distributions, either directly from an existing 401(k) or from an IRA after rollover. Theoretically, the bulk of the retirement investment funds will still be growing from gains on the underlying assets that will help retirees keep pace with inflation and minimize the chances of the money running out. However, a disadvantage is that those funds will face continued exposure to the gyrations and ups and downs of the markets and so could decrease in value. What is a retiree to do when faced with the twin risks of the possibility of not being able to withdraw enough each month to assure a comfortable retirement and the chance of running out of money before running out of years? An immediate annuity might be the solution.
What Immediate Annuities Are and How They Work
Immediate annuities are financial products where a person typically makes a single payment to an insurance or investment company and then receives in return a series of periodic payments (monthly, quarterly, or annually) over a defined future period. There are two types of immediate annuities, fixed annuities and variable annuities.
With a fixed annuity, the owner receives the same amount each period. With variable annuities, however, the payments vary since they depend on the returns on the annuity investments. For those with the goal of establishing a steady, predictable stream of retirement income, the fixed annuity would be the preferred choice.
The amounts of the payments from a fixed annuity depend on several factors:
- The amount of the single payment (or premium) to establish the annuity.
- The length of the payment period chosen (life or for a set number of years).
- Whether a guaranteed payout period is opted for.
- Whether any survivor options were included.
When purchasing an annuity, a payment period is chosen. The purchaser may for example choose to receive payments for life, payments for the life of the annuitant and a spouse or other survivor, payments for a specific number of years (termed a period certain annuity) or for a specified period with a guaranteed minimum number of payout periods. For example, a period certain annuity might be purchased for a 20-year period with a 5-year guarantee. In that circumstance if the annuitant were to die after the first three years, the payments would continue for the remaining two guaranteed years to a beneficiary.
Immediate annuity payments begin immediately, hence the name. For example someone making the initial payment (paying the premium) to establish an immediate annuity on a date in any month would receive their first annuity payment the following month.
Annuities Pros and Cons
There are both advantages and disadvantages associated with immediate annuities.
Advantages:
- A locked in, steady stream of income of a known periodic amount.
- Payouts can last for life.
- Favorable tax treatment.
- Simple since issuer is responsible for investments not the annuitant.
- Payments can be higher than a retiree might be able to achieve on their own.
- Low-risk investment as solid as the financial condition of the issuing company.
- Annuity payments can serve as a complement to other retirement income sources.
Disadvantages:
- Some annuities involve sales commissions.
- If contract allows for surrender, surrender fees can be steep.
- Unless survivor options are chosen, payments end at the time of death.
- Fixed payments are a set and may not keep pace with inflation.
Despite the disadvantages, fixed immediate annuities can be a good choice for those who want to assure a steady flow of income during retirement that removes the uncertainty over whether enough money will be available to meet monthly living expenses or whether they will outlive their nest egg.
Where to Buy Annuities
Most major insurance companies offer immediate annuities. Chances are an insurer already used by a prospective purchaser for life insurance would be a ready source for annuities. In addition, many large investment companies offer them as well.
Annuity calculators exist on the web that can be used by those considering an immediate annuity to run “what if” scenarios using various initial premium amounts, payout periods, and options. There are also sites where instant quotes can be obtained that will show based on options selected just how much periodic payments would be based on the initial investment or premium amount.
References:
Intermediate annuities: Do-it-yourself pensions. Bankrate.com. Web. 23 Jan. 2010.
Monthly Checks for Life: 5 Rules for Immediate Annuities. CBS Money Watch.com. Web 23 Jan. 2010.
Larry Darter - Larry Darter is a freelance writer and published author with three books to his credit. He is a graduate of the Univ. of Central ...
