Should You Annuitize with an Immediate Annuity?

Retirement is here and it’s time to start planning an income strategy.  You have your mutual funds, stocks, bonds, CD’s and annuities.  Does it make sense to annuitize your annuity? It just might be. Here’s why baby boomers are choosing immediate annuities.

The fear of outliving your savings is a scary reality. What if you could plan so that you spent your last dollar on the last day of your life? An immediate annuity might be the answer.

Should you buy immediate annuity for income now?

Benefits of an Immediate Annuity

If you want a guaranteed income like a pension or Social Security, an immediate annuity is one of the few investment tools that can do so.  They are backed by insurance companies, so of course its important to do your research and make sure the company has good ratings.

As long as you are alive, the insurance company will continue to make payments just like a good renter does to a landlord. When your gone, so are the payments.

Immediate annuities provide “immediate” income. There are two phases to an annuity: the accumulation phase and the income phase.

Accumulation Phase is When it Grows

Then, at a certain date, the income phase begins – and payments are made to the annuity holder out of the accumulated principal. With an immediate annuity, you don’t have to wait years for income payments to start. You put a lump sum of money into the annuity, and the payments begin – usually about a month after you set up the annuity contract. (Some “immediate” annuities let you defer income payments for up to one year.)

Different Payout Options for an Immediate Annuity

A life-only option gives you an income for the remainder of your life. Select a joint and survivor option, and you can add a second life to the contract – that is, payments will continue to be issued to your surviving spouse for the rest of his or her life after you pass away. Or, you can simply structure an annuity payout to last a set number of years.

Longevity has its rewards.

If you know a little about the insurance industry, you know insurance policies and annuities are structured around projections of life expectancy. With an annuity, if you die sooner than expected, the insurance company won’t have to pay you as much income as projected. If you outlive their projections, they will have to pay you more. So the healthier you are, the more attractive immediate annuities are.

If your immediate annuity is a life annuity (income payments for life), the older you get, the greater those payments will be. (Life expectancy for annuity payout purposes is determined by insurance company experience and not as a result of a physical examination. If you have a joint and survivor annuity, two lives are used in the calculation and the amount of the payout is smaller than with a single life contract.)

Immediate annuity income can also be affected by insurer assumptions. That is, it may be assumed that the balance of the annuity will earn __% interest or a ___% return annually. Lower interest rates or investment assumptions will lead to a lower income stream.

The after-tax advantage.

If an annuity is purchased with after-tax money, the income stream comes with significant tax advantages. Let’s compare and contrast here. In a deferred annuity, all earnings and investment results grow tax-deferred during the deferral phase. But when income phase starts and the tax-deferred earnings are paid out, the tax collector wants his fair share.

Since an immediate annuity is paying back both principal and tax-deferred earnings, a portion of each payment is considered to be income, and a portion is considered to be tax-free return of principal. The shorter the payout period, the greater the amount that can be excluded from tax.

Immediate annuities can be used in IRAs that require minimum distributions beginning at age 70 ½. These minimum distribution rates are designed to distribute out the entire balance of an IRA over a person’s lifetime. With longer lifespans, the tables the IRS uses for this calculation are fast becoming obsolete – and that raises the very real threat of outliving your IRA assets. However, if those assets are invested in an immediate annuity, a lifetime income stream can be assured and the IRS will accept that income stream amount as an acceptable minimum distribution.

So, does it make sense to annuitize?

If you’re healthy, active and mature, an immediate annuity can potentially be a great income source for you. Before you arrange an annuity contract, talk to an advisor or insurance agent who understands these investments thoroughly, one who can explain your options.

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