a financial tool that guarantees regular income, usually for retirement.
Immediate Annuity Details
People generally buy annuities from an insurance firm. They allow their money to grow in the fund over a period of time and receive a preset amount every year. Sometimes, it can take years before the payouts begin. With an immediate annuity, the person makes one lump sum payment and begins receiving payouts right after purchase.
Payouts from immediate annuities depend on several factors—naturally, the bigger the contribution, the bigger the payout. However, insurers are known to offer a variety of options, such as:
lifetime annuity, which pays out for as long as the insured is alive
joint lifetime annuity, which pays out while the insured or the spouse is alive
period annuity, where payouts are made only within a predetermined period.
Besides off the bat payouts, an immediate annuity offers many other benefits, such as compounded growth due to its tax-deferred status. Those who annuitize taxed money can also enjoy an essentially tax-free income source. In some cases, immediate annuities can come with the cost-of-living adjust option, which serves as a good buffer against inflation, plus a liquidity feature that comes in handy during financial emergencies.
Example of Immediate Annuity
Jamie is an office worker planning to purchase a fixed immediate annuity with a principal amount of $100,000 and an annual growth rate of 2%. She has decided to structure her contract for monthly payments, but she also wants to know exactly how much she will get with each payout. She does her research and finds that five variables are involved in the calculation: principal amount (P0), monthly payment amount (MPA), annual interest rate (r), number of yearly payments (n), and number of years of payments (t).
Here is the formula that determines Harley’s monthly annuity payments: P0 = [1-(1+r/n)-nt] / (r/n). With this, Jamie finds that she will be receiving a monthly payout of $505.88 for a $100,000 annuity with a 2% growth rate over 20 years.
Types of Immediate Annuity
Immediate annuities, or single premium immediate annuities (SPIA), come in three key types: fixed, inflation-indexed, and variable. In a fixed annuity, the amount of the payout is constant throughout the term of the contract, as opposed to an inflation-indexed annuity, where the amount rises and falls yearly with inflation.
A variable annuity tends to be more complicated. It is directly tied to the performance of an underlying investment portfolio, which is typically composed of stock and bond mutual funds. Hence, payments are expected to change every month or at least every year, depending on the contract structure. In any case, choosing the immediate annuity that works for you depends on your current financial circumstances and retirement plans.
A fixed annuity is good for those who want assured and consistent retirement income they cannot outlive. Those who want to protect their money can pick the inflation-indexed type, although this comes with the risk of lower payouts. For an immediate annuity that also serves as an investment, the variable type is the best, but payouts can also vary in amount.