Immediate Annuities
In this type of annuity the owner has swapped a premium for a fixed and guaranteed stream of income, either for life, or a predetermined period of time.
It is important to note that unlike other annuities that can be accessed with a penalty fee, this type of annuity cannot be accessed once it has been made. Money put in can never again be taken out and is swapped irrevocably in exchange for the fixed yearly income.
The amount of income received each year never goes up, while inflation rates remain subject to change. In practice this usually means that the annuity holders ability to purchase will gradually decrease over time as the income received falls behind increasing rates of inflation in the market. Put simply the buying value of a dollar will not be the same 10 years from now, and it is important for those interested in this type of annuity to be aware of such factors.
When selecting an immediate annuity it is best to do so within a high interest rate environment as these lead to high interest rate annuities depending on the age of the prospective client. Younger clients are more likely to live longer and receive more money over time. As a result they are usually given less desirable amounts of income.
For example, let us say that John makes an initial deposit of $100,000 and receives an annual income of $7,000 from the annuity. If John were to live another 30 years he would receive a total of $210,000. In this scenario John has surpassed the value of his initial deposit.
To use another example, let us say that John makes the same initial deposit of $100,000 with the same annual income of $7,000, but he only lives for another 3 years. During this time John would only have received $21,000 but the remainder of his deposit would pass to the insurance company.
In the previous example John has effectively lost $79,000. He handed over $100,000 and got back only $21,000. That's like handing over a dollar of your money and being handed back 21 cents. This type of annuity can be a gamble, and the odds of winning are often stacked against the individual annuity holder.
Based on the previous examples it becomes apparent that the effectiveness of immediate annuities is based on the amount that is given as a yearly income rate multiplied by the number of years that the rate is received. If the total amount received exceeds the initial deposit then profit has been made on the part of the annuity holder. If, however, the combined yearly income accumulated over time does not exceed the initial deposit then the insurance company ends up making the profit.
The yearly income paid to immediate annuity holders is tied directly to the projected life expectancy of the client, and is further conditioned by the prevailing interest rate at the time the annuity was issued. Annuities of this kind should be approached with caution.
Prospective clients should be aware that the income received from an immediate annuity is considered as part return of principal, which is not taxable, and part interest, which is subject to income taxes. Additional caution should be exercised by individuals with family, friends, or loved ones that they wish to provide for.
Purchasers of immediate annuities typically have a range of options that they can select only when applying for the annuity and prior to it being issued. Once the annuity has gone into effect it is impossible to change. For many potential clients this level of inflexibility can represent a major drawback that detracts from the perceived value of the annuity.
It should be noted that there are several options for immediate annuities. There is, for example, an option called 'period certain' that allows the holder of the annuity to pass on their yearly income to a beneficiary for a fixed period of time. Options such as this can help to make the annuity more attractive; however, they usually come with a cost in the form of a reduced income.
Here at Retirement Council of America we recognize that it is necessary to tailor our services to the unique needs and expectations of our clients. Different clients have different needs, and for some of our clients immediate annuities can represent a desirable option.
For the majority of our current and future clients it is necessary to advise caution with regard to immediate annuities. It should also be noted that there is an immediate annuity that gives an enhanced rate to people in poor health, with less than normal life expectancies. A great degree of caution needs to be applied here.
Before these or other types of immediate annuities become a viable alternative the following needs to be in place: the client must be at a sufficiently advanced age, the current interest rates must be high, and the client must have no desire to leave the primary deposit money to family, friends, or loved ones.