Understanding Immediate Payment Annuities: A Path to Guaranteed Income
An immediate payment annuity is a contract between an individual and an insurance company that pays the owner, or annuitant, a guaranteed income starting almost immediately. It differs from a deferred annuity, which begins payments at a future date chosen by the annuity owner. An immediate payment annuity is also known as a single-premium immediate annuity (SPIA), an income annuity, or simply an immediate annuity.
Key Advantages
- Immediate payment annuities are provided by insurance companies and can give the owner income almost immediately after purchase.
- Buyers can choose from monthly, quarterly, or annual income options.
- Payments are generally fixed for the term of the contract, but variable and inflation-adjusted annuities are also available.
How Immediate Payment Annuities Work
To purchase immediate payment annuities, individuals typically pay an insurance company a lump sum of money. The insurance company, in turn, promises to pay the annuitant a regular income according to the terms of the contract. The amount of those payments is calculated by the insurer based on factors such as the annuitant’s age, prevailing interest rates, and the duration of the payments.
Payments typically begin within a month of purchase. Annuitants can decide on the frequency of the payments, known as the “mode.” Monthly is most common, but quarterly or annual payments are also an option.
People often buy immediate payment annuities to supplement their other retirement income, such as Social Security, for the rest of their lives. It is also possible to purchase an immediate payment annuity that will provide income for a limited period, such as 5 or 10 years.
The payments on immediate payment annuities are generally fixed for the period of the contract. However, some insurers also offer immediate variable annuities, which fluctuate based on the performance of an underlying portfolio of securities, much like deferred variable annuities. Another variation is the inflation-protected annuity, which promises to increase payments in line with future inflation.
Immediate payment annuities present a gamble: Annuitants who die too soon may not get their money’s worth, while those who live a long time can come out ahead.
Important Considerations
One potential drawback of an immediate payment annuity is that payments typically end upon the death of the annuitant, and the insurance company retains the remaining balance. As a result, an annuitant who dies earlier than expected may not get their money’s worth out of the deal. On the other hand, an annuitant who lives longer could come out ahead.
There are ways to address this issue. One is by adding a second person to the annuity contract (referred to as a joint and survivor annuity). It’s also possible to buy an annuity that guarantees payments to the annuitant’s beneficiaries for a certain period, or one that will refund the annuitant’s principal if the annuitant dies early (known as a cash refund annuity). Such provisions, however, come at an additional cost.
Once purchased, an immediate payment annuity cannot be canceled for a refund. This may pose a problem if the annuitant needs the money in a financial emergency. Therefore, it is prudent to have an emergency fund set aside for unforeseen needs before deciding how much money to place in the annuity.
Related Terms: deferred annuity, variable annuity, inflation-protected annuity, joint and survivor annuity.
