An immediate annuity is an insurance product that provides a guaranteed income: you give an insurer a chunk of money, and the company gives you a stream of payments that can last a lifetime. Payments begin within 12 months of purchase.
This could be a good time for retirees to buy an immediate annuity as payouts are the highest in a decade, says Rob Williams, director of wealth management at Charles Schwab.
But buying an immediate annuity, also called an income annuity or a fixed immediate annuity, is essentially irreversible, so you’ll need to choose carefully.
WHY YOU MIGHT CONSIDER AN IMMEDIATE ANNUITY
One of the big risks of retirement is living beyond your savings. If you have enough guaranteed income to cover basic expenses, you can rest assured that you will have a roof over your head and food in the refrigerator no matter what.
A major source of guaranteed income is Social Security, and some people still have traditional pensions. However, if you don’t have enough guaranteed income to cover essential living expenses, an immediate annuity could fill 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 should also invest money in stocks for growth, as well as cash reserves for emergencies.
Immediate annuities can help you exit the markets, Williams notes. The steady stream of income could help you avoid selling investments to cover living expenses, he says.
HOW MUCH YOU CAN GET FROM AN INSTANT BODY
There are many types of annuities, and some are mind-bogglingly complex. In contrast, immediate annuities are relatively simple: 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 a woman aged 65 who invest $100,000 can expect to receive a monthly check of about $535 if they choose the joint life option, where payments continue for both lifetimes, according to Charles Schwab’s annuity income estimator. If they choose a cash repayment option, the monthly check drops to about $532, but their heirs will receive whatever money is left if the couple dies before they get back their original investment.
That’s a relatively cheap form of insurance and could provide some reassurance to people who worry that the insurance company will “win” if they die prematurely, Williams says.
Payouts also depend on the insurer. According to the online marketplace ImmediateAnnuities.com, monthly checks for the couple can range from $513 to $565 per month for the joint life option, depending on the company.
Some companies sell annuities with cost-of-living adjustments in each subsequent year, but the 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 adjusted for inflation, and investments in stocks, which provide inflation-reducing returns over time, Pfau says.
PLEASE NOTE THE INSURANCE RATINGS
Because payouts vary, shop around, but also consider the insurance company’s rating. A financially weak company may not be there 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 insurance association will protect your annuity up to certain limits if your insurer fails. For example, in California, the association covers 80% of the 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’s coverage limit, consider buying from several different companies so that all your eggs aren’t in one insurer’s basket, Williams says. You can also “ladder” your purchases by purchasing immediate annuities every year or every few years. Annuity payouts are tied to the yield on highly rated corporate bonds, so laddering allows you to take advantage of higher payouts on newly purchased annuities as bond yields rise – although payouts may decline if bond yields fall, he notes.
How your payouts are taxed depends on where you got the money to purchase the annuity. If the money comes from an after-tax account, such as a savings or investment account, a portion of each payment is considered a return on your investment and is not taxed.
If you purchase the annuity with money in a qualified retirement account, such as an IRA or 401(k), the payouts are generally taxable, but so is any withdrawal from such a source. The money used to purchase an immediate annuity is not considered part of your retirement fund when it comes time to calculate required minimum distributions, which usually must begin at 73. That could be a boon for big savers who worry about such distributions. end up in 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 your own income can be difficult and annuities can be a good tool,” he says.
This column was provided to The Associated Press by the personal finance site NerdWallet. The content is for educational and informational purposes and does not constitute investment advice. Liz Weston is a columnist at NerdWallet, a certified financial planner and author of “Your Credit Score.” Email: [email protected]. Twitter: @lizweston.
NerdWallet: How Long Will My Money Last When I Retire? Calculator, how to stretch it https://bit.ly/nerdwallet-how-long-will-your-retirement-money-last