What is an immediate annuity?

Like other annuities, an immediate annuity makes it possible for an individual to turn a lump sum of cash into a guaranteed income stream. Yet while other annuities remain untouched to accumulate funds, an immediate annuity skips the accumulation phase and begins to issue income payments soon after it is purchased - usually after 30 days.

How does an immediate annuity work?

After an immediate annuity is purchased, the owner must select an income payment option, which is known as a settlement option. The settlement option determines how the insurance company will distribute the income payments. For example, if a "Life" option is selected, the insurance company will provide the annuitant with a monthly income for as long as he or she lives - guaranteed. (In some cases it is also possible to receive payments over the combined life expectancies of both the annuitant and his or her spouse.) If a "Period Certain" option is selected, the insurance company will provide a monthly income payment for a specified period of time, such as 10 years. The amount received each month is determined by the size of the original premium, the applicable interest rate and the annuitant's life expectancy or specified period of time. Once this amount has been established, it cannot be changed. (These examples are only two out of a variety of settlement options available. Please contact us for more information on other possible settlement options such as "Life with Period Certain," "Joint and Survivor," "Cash Refund," "Installment Refund," etc.)

How much of the periodic payment is taxable?

Each payment is part nontaxable return of principal and part taxable interest income. In order to determine what percentage of the monthly payment is nontaxable, the Exclusion Ratio must be applied. The Exclusion Ratio for each individual annuity is the ratio of the total investment to the total expected return. For example, if the investment in the annuity is $12,650 and the expected return is $16,000, the Exclusion Ratio is $12,650 divided by $16,000 - which equals 79.1% (rounded to the nearest tenth of a percent). So if the monthly payment is $100, the portion that is nontaxable is $79.10 (79.1% of $100), and only $20.90 a month is taxable.

Who should consider buying an immediate annuity?

Immediate annuities are perfect for individuals who have already retired and need annuity income right away - especially if these individuals have lump sums of money to invest. (These individuals should also consider purchasing an immediate annuity as part of a triple-split annuity. For more information on this innovative concept, visit the "Triple-Split Annuity" link.) This type of annuity is also perfect for an individual who is concerned about outliving his or her income, because if an annuitant chooses a Life settlement option, the monthly income payments are guaranteed to continue as long as he or she lives - even if the annuitant outlives his or her life expectancy. When considering an immediate annuity, it is important to remember that annuity distributions received prior to age 59 ½ may be subject to a 10 percent IRS tax penalty (excise tax), unless the specifications of Pre-LERO (I.R.C. Section 72(t)) are followed. If you are under the age of 59 ½ and want to learn more about the beneficial Pre-LERO option, visit the "Avoiding Penalties" link of the Learning Center.

What are some other benefits of an immediate annuity?

In addition to the feeling of security that comes from knowing you cannot outlive your income, there are many other reasons to purchase an immediate annuity. First of all, immediate annuities offer simplicity because you do not have to manage your investment or even watch the market, and the monthly payments can be deposited directly into your banking account. Annuities also offer an additional tax benefit on investments because part of each check is a nontaxable return of your original investment, which results in lower annual income taxes.