An immediate annuity is an insurance product that provides a guaranteed income. When you give a large amount of money to an insurance company, the company gives you a stream of payments that last a lifetime. Payments begin within 12 months of purchase.
Rob Williams, managing director of wealth management at Charles Schwab, says now may be a good time for retirees to buy an immediate annuity, as annuity payments are at their highest in a decade. He says he can’t do it.
However, purchasing an immediate annuity (also known as an income annuity or a fixed immediate annuity) is virtually irreversible, so choose carefully.
Why you should consider an immediate annuity
One of the big risks in retirement is outliving your savings. Having a guaranteed income that is enough to cover your basic expenses gives you the peace of mind that no matter what, you have a roof over your head and the ability to keep food in your fridge.
The main source of guaranteed income is Social Security, and some people still receive traditional pensions. But if you don’t have enough guaranteed income to cover essential living expenses, an immediate annuity can fill the gap, says Wade Fau, author of the Retirement Planning Guidebook.
But getting your pension right away shouldn’t be an “all-or-nothing” solution, Pfau says. Ideally, you’ll also have money to invest in stocks for growth and a cash reserve for emergencies.
Immediate annuities can help weather down markets, Williams said. With a steady income, you may not need to sell investments to cover living expenses, he says.
How much can I receive from an immediate pension?
There are many types of annuities, some of which can be mind-bogglingly complex. In contrast, immediate annuities are relatively straightforward. Payment amounts vary widely depending on the amount invested, your age, prevailing interest rates, and the payment option you choose.
For example, a 65-year-old man or woman with $100,000 invested can expect a monthly check of about $535 if they choose a co-living option with lifelong payments, according to Charles Schwab’s pension income estimates. If you choose the cash-back option, your monthly check will drop to about $532, but if the couple dies before you get your original investment back, your heirs will receive the remaining money.
This is a relatively inexpensive insurance policy that can provide some peace of mind for people who worry that their insurance company will “win” if they die early, Williams says.
Payment amounts also vary depending on the insurance company. Depending on the company, a couple’s monthly check can range from $513 to $565 a month for the co-living option, according to the online marketplace ImmediateAnnuities.com.
Some companies sell annuities with cost-of-living adjustments for each subsequent year, but the initial payments are much smaller. According to ImmediateAnnuities.com, for our hypothetical couple, initial payments will range from $359 to $379, with a 3% annual inflation adjustment.
Fau notes that inflation protection may not be necessary if retirees have Social Security benefits adjusted for inflation and have stock investments that provide returns that outpace inflation over the long term. .
Pay attention to insurance company ratings
Payment amounts vary, so it’s wise to shop around, but you should also consider the insurance company’s rating. Financially weak companies may not be able to make promised payments. (Schwab’s online marketplace includes insurance companies rated A+ or higher by Standard and Poor’s, while ImmediateAnnuities.com includes insurance companies rated A- or higher by AM Best. )
If the insurance company goes bankrupt, the state guaranty association will protect your pension up to a certain limit. For example, in California, the association covers 80% of the pension amount up to $250,000, but the maximum compensation per individual is her $300,000.
If you want to invest beyond your state’s coverage limits, consider buying from a variety of companies so you don’t have all your eggs in one insurance company’s basket, Williams says. You can also “ladder” your purchases by purchasing an immediate annuity every year or every few years. Because annuity payments are tied to yields on high-quality corporate bonds, laddering allows you to take advantage of higher payments on newly purchased annuities if bond yields rise, but Payments could shrink if yields fall, he said.
How your payments are taxed depends on where you got the money to buy the annuity. If the cash comes from an after-tax account, such as a savings or brokerage account, a portion of each payment is considered investment income and is not taxed.
If you purchase an annuity with funds from a qualified retirement account, such as an IRA or 401(k), the payments are generally taxable, as are withdrawals from such sources. Funds used to purchase an immediate annuity are not considered part of your retirement savings when calculating the required minimum distribution amount (which typically needs to start at 73). This could be a boon for large savers who are concerned about such distributions being pushed up. will be raised to a higher tax rate.
Immediate annuities aren’t the answer for all retirees, but they can be an effective way to buy peace of mind, Williams says.
“Earning your own income can be tough, but pensions are a good way to help with that,” he says.
Liz Weston is a NerdWallet columnist, certified financial planner, and author of Your Credit Score. Email: firstname.lastname@example.org. Twitter: @lizweston.
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