Immediate annuities are the simplest and most straightforward of all annuity products. They are also the only annuity product most experts can really recommend.
What Is An Immediate Annuity?
In short, an immediate annuity is a contract between you and an insurance company where the insurance company agrees to pay you a monthly income in exchange for a one-time lump sum payment (see Annuities Explained for a more detailed explanation). Sounds a lot like a bond or dividend-paying stock, right? Immediate annuities have two primary advantages over other forms of income-oriented investments (like balanced mutual funds, for example):
- The Income Never Stops – Most immediate annuities pay for life (and sometimes for the life of your spouse, if you’re willing to pony up for it). Contrast that with a bond, which has a finite due date, or a stock, which can cut its dividend at any time. With an annuity contract, the insurance company is on the hook for sending you that monthly check as long as you live, even if it’s to 105. In the event your insurer goes bankrupt, annuity payees get first dibs on the company’s assets. Furthermore, most states have annuity-guarantee funds similar to FDIC insurance for bank accounts. If the insurer goes bankrupt, the state will step in to make you whole up to a pre-defined limit. Be sure to know your state’s laws and split your annuity money between two (or several) different high-quality insurers if necessary.
- Cash Payouts Tend To Be Higher Than With Other Investments – You’d be lucky to find a stock or bond paying 6% right now without taking an extraordinary amount of risk. It’s not at all difficult, however, to find an immediate annuity with a payout that high. Since insurance companies generally get to keep the full lump sum even if you die the day after you annuitize, unlucky pensioners who die early sub-size higher returns for those who live longer. The insurance company will turn a profit in the long run, to be sure, but annuitants who live longer than average after annuitizing generally end up getting quite a good bargain.
Because of these unique characteristics, some experts have begun recommending older investors use immediate annuities rather than bonds in order to boost their income and decrease their risk at the same time. At the very least, it’s worth running the numbers if you’re nearing or already in retirement.
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