What is an 'Immediate Payment Annuity'

An immediate payment annuity is an annuity contract that is purchased with a single payment and pays a guaranteed income that starts almost immediately. Also called a "single-premium immediate annuity (SPIA)," "income annuity" or simply an "immediate annuity," an immediate payment annuity generally starts payment one month after a premium is paid and continues for as long as the annuitant (buyer) is alive or for a specific period of time. The longer an annuitant lives the better their return will be. Such annuities are especially suitable for retirees who are concerned about outliving their savings.

Breaking Down 'Immediate Payment Annuity'

Immediate payment annuities are a valuable retirement planning tool in that they provide a reliable and inexhaustible income stream. In effect, they function as a risk management tool that works like a mirror image of life insurance (which pays a benefit at death). Their simplicity makes them a popular option; no need to attempt to time the market or worry about distribution timing. Also, immediate payment annuities, as opposed to front-loaded annuities, can help lower taxes by deferring payments to a time when the annuitant is in a lower tax bracket.

Immediate Payment Annuities: Choices

The needs of a retiree, as well as their age and life expectancy, will dictate which immediate payment annuity is right for them. A few things to decide include whether they should maximize income now (a fixed payout) or take a lower payout initially but index future payments to inflation. Annuitants may also choose whether they want a fixed/guaranteed payout or a variable payout, which may feature a base payout and an added portion tied to the performance of a stock index, a payment entirely pegged to a stock index or to bond performance. Annuitants may also decide how often they are paid, known as a "mode." A mode can be monthly (the most common), but also quarterly or annually.

Immediate Payment Annuities: Drawbacks

One large drawback of an immediate payment annuity is that payments end upon the death of the annuitant. If an annuitant dies earlier than expected, payments stop and the insurer or financial institution that sold the annuity keeps the principal balance. Since the annuity payments are terminated upon the death of the annuitant, financial advisors and planners do not recommend this type of annuity for retirees who are not in good health. Some ways around this fact is by adding a second person to the annuity (joint and survivor), or guaranteeing that payments are made for a certain period, orĀ  seeing that the principal is fully refunded (refund annuity). Such provisions cost more, however.

Once purchased, an immediate payment annuity cannot be canceled for a refund of principal from the seller. This may pose a problem should the annuitant require access to a large sum of money to deal with an emergency.

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