Why people buy immediate annuitiesArticle added by Jason Kestler on June 27, 2011
Ranked: #31 (1,618 pts)
A purchase of an immediate annuity is essentially a trade: you give an insurance carrier a lump sum of money, and the carrier agrees to provide you with a guaranteed periodic stream of future payments.
An article in the Wall Street Journal in February 2000 said it best: “Retirement is the great financial riddle. Think of the uncertainties. You don’t know how long you will live. You don’t know what investment returns you will earn. You only have a limited sum of money. And there are no second chances. One possible solution: immediate fixed annuities.”
For retirees who are not receiving traditional pension benefits, immediate annuities provide peace of mind by providing steady checks. They have been called “paycheck annuities” by prominent national commentators.
A purchase of an immediate annuity is essentially a trade: you give an insurance carrier a lump sum of money, and the carrier agrees to provide you with a guaranteed periodic stream of future payments. Once you purchase the annuity contract, the amount and duration of the payments are fully guaranteed by the issuing insurance carrier. As a result, immediate annuities are very easy to understand.
When you purchase the contract, you and the carrier will agree upon how payments will be made, such as:
Once the contract is made, it is generally irrevocable and binding on both parties. The strength of that for you, as the purchaser, is that you have transferred certain risks onto the insurer. For example, no matter what rate of return the insurer achieves or fails to achieve, no matter how interest rates change over time, and no matter how long you live, the insurance carrier is contractually obligated to make the guaranteed payments to you. Thus, you have transferred investment, interest rate, and longevity risk to the insurer.
Because once you own an immediate annuity, you have no options (or very limited options) to cash it in or sell it, you should only allocate a portion of your retirement savings to the purchase of an immediate annuity. You may want to consider choosing a payment option that includes a cost of living inflation adjustment and that provides for your heirs.
- Will they be made monthly, annually, or at some other frequency?
- Will they continue for a certain number of years?
- Will they continue for as long as you live?
- Will they continue for as long as either you or your spouse is still living?
- Will they increase over time with an inflation adjustment?
- Will there be a remaining value after your death for your beneficiaries?
While immediate annuities may be new to you, defined benefit pension plans have been using immediate annuities for years. An employer will steadily save money while a worker is working for the employer, and when the worker retires, the employer now owes the worker a monthly income for the rest of his or her life. Many employers will go to an insurance company and give them the sum of money that has been saved in exchange for the insurance company taking over the obligation to pay the worker for life.
Because of their simplicity, immediate annuities from various carriers are easily compared. Once you and your insurance agent decide upon the type of payout you desire and either the funds available to purchase it or the income desired, the decision of which carrier to choose typically rests upon which carrier offers the best price or payout and the financial strength of the carrier. Keep in mind that the payment guarantee is supplied by the issuing carrier, thus the financial strength of the issuing carrier is an important consideration in the purchase of an immediate annuity.
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