Immediate Annuities: Money Now and for the Rest of Your Life ... for a Price

Some dream of spending their golden years in exotic locations, indulging in exciting trips to ancient ruins and sampling spicy, local cuisine. But when it comes to retirement savings, even the most adventurous seniors may still consider something routinely described as "plain vanilla": a fixed immediate annuity.

Perhaps the simplest of all the annuity options, a fixed immediate annuity does what its name suggests. It begins delivering steady income shortly after an investor buys a contract, often within 30 days and always within 13 months. A variable immediate annuity also delivers income quickly but, unlike with fixed annuities, your payments will fluctuate.

An immediate annuity is a contract between an investor and an insurance company, with the investor paying the insurance company a lump sum in exchange for regular income payments. Those income payments may be paid monthly, quarterly, semiannually or annually and are generally guaranteed to last as long as the contract holder is alive—or, depending on the terms of the contract, for a set period of time such as 10 or 20 years.

Fixed Immediate Annuities

Fixed immediate annuities have guarantees that can offer comfort to retirees who worry about the risks of keeping their money in financial markets. When you buy a fixed immediate annuity contract, you are guaranteeing that your monthly (or other periodic) income payments will remain the same, regardless of market conditions, for the time period specified in the contract.

The drawback of such a guarantee for fixed immediate annuities is that it won't bring big bucks. Fixed immediate annuity payments typically trail the returns that investors would see on equity and bond portfolios during a bull market.

Thus, the tradeoff for predictability might be lower returns when compared to what your money might have generated had you invested in the markets.

Another drawback to fixed immediate annuities is that, as time passes, a retiree with an annuity that offers a fixed payment amount may find that their regular payments don't stretch as far as they once did due to inflation. Annuity buyers can sometimes purchase riders with the contract that feature cost-of-living increases or fixed increases to soften the blow of inflation but, as with other riders, this will increase the cost of the annuity and may lower your overall returns.

Investors should evaluate their risk appetite when considering fixed immediate annuities. Retirees with a high risk tolerance and the ability to absorb risk may be turned off by fixed immediate annuities' conservative returns, but those with low risk tolerance and a wariness of market volatility may feel differently.

Variable Alternatives

Investors who want to receive annuity payments immediately along with the possibility of higher returns might want to consider variable immediate annuities. Variable immediate annuities, like other variable annuities, allow you to allocate your principal into a wide array of underlying investments, including stocks, mutual funds and bonds. Your allocations typically aren’t set in stone, allowing you to move money out of one underlying investment and into another.

Unlike fixed immediate annuities, the value of your variable immediate annuity—and the payments you ultimately receive—will fluctuate based on how your underlying investments perform, meaning that investors have the potential to reap rewards if their investments grow but could also lose money if their investments flounder. As such, variable immediate annuities are considerably riskier than their fixed counterparts.

The Benefits of Living Longer

In general, those who may benefit most from immediate annuities are healthy people who expect to live longer-than-average lives. If your life were to be unexpectedly cut short, you would have received relatively little in annuity payments. And, unless your contract includes a death benefit or you have purchased certain riders, your surviving spouse or your heirs would not be entitled to any payments under a standard contract guaranteeing lifetime payments.

To mitigate the financial implications of dying earlier than expected, when purchasing an immediate annuity contract, you can generally purchase a rider to allow a beneficiary to receive some money from the annuity after your death. For example, some immediate annuities offer a period certain benefit, which guarantees that some amount of payments will be made to a beneficiary for a certain period of time after the contract holder dies. But a contract with this rider—or with any other sort of death benefit—will cost more. That means it will require a higher lump sum payment at the outset for the same amount of annuity income.

Investors considering immediate annuities should do their research and shop around because insurance companies may offer different features in exchange for the same lump sum payment.

And with all annuities, investors should remember that the annuity is only guaranteed as long as the insurance company issuing it remains in business, so you’ll want to be sure you are comfortable with the issuer, not just the product itself.