The Anatomy of Fixed Immediate Annuities

Physician's Money Digest, November 2007, Volume 14, Issue 11

Some of the negative comments about annuities deal with cost and/or complexity due to charges for mortality, expenses, account management and administration, and special features and riders. It can be challenging for most consumers to understand exactly what they are buying and whether the price is worth it. While much of this negativity has been earned, the simpler cousin of these annuities, the immediate annuity, has been largely forgotten.

How Immediate Annuities Work

With an immediate annuity, a lump sum is paid to an insurance company, which will then agree to pay a set amount of money for the remainder of an insured's life. The income stream is normally based on two major factors: life expectancy and rate of return the insurance company assumes as the crediting rate. These calculations are made by the insurance company and presented in the form of an offer with various payout methods such as single life, joint life, or for a specified period.

A single life payment provides income for the insured's entire life; however, remaining money left after death cannot be paid out to any beneficiary. Joint life payments continue to pay an income to a surviving beneficiary after the death of the insured. Remember, Federal income tax may be due on withdrawals and a 10% tax penalty may apply to withdrawals made prior to age 591/2. Withdrawals can also lower the cash value and decrease the death benefit.

Some financial planners have been reluctant to recommend immediate annuities because if the client chooses the single life payout option and dies right after the annuity has begun, then the money is no longer available for beneficiaries. This is the risk of dying too soon. However, some financial planners are becoming more concerned about the risk of living too long.

One way to mitigate some of that risk is to purchase an immediate annuity that would cover basic lifestyle expenses. This could provide a little balance to a retiree's cash flow and maybe a bit of stability as well.

Medical Complications

A little-known corner of the immediate annuity world is the medically underwritten segment also known as "rated age." In life insurance, those with poor health pay higher premiums because their life expectancy is not as good as someone who is healthy. Rated-age annuities work the same way in reverse. Since a less healthy person can have a shorter life expectancy, some insurance companies are willing to pay that person a larger monthly income stream.

Not all insurance companies offer this type of annuity and of those that do, not all see each medical condition the same way. There is as much art as science in these decisions.

In the right situation an immediate annuity can work to one's advantage. Having a known income stream that is designed to last as long as you do might help make retirement more enjoyable.

The Bottom Line

  • An immediate annuity provides a set amount of money for the remainder of an insured's life.
  • Immediate annuities can provide additional funds for your retirement.
  • Rated-age annuities may be helpful for those with serious medical conditions.

Greg Reed, CFP®, CFS, CLU®, MBA, is the Director of Planning for Smith, Frank & Partners, LLC and co-author of Countdown. He welcomes questions or comments at gregreed@smithfrank.com or 972-490-4377.