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Money for Today or the Rest of Your Life?


When planning your retirement, there are two basic subtypes of annuities for you to consider; immediate or deferred. The main difference between the two is when you want to begin receiving payments. And, that decision boils down to your specific financial goals.

To help you pick the option that aligns best with your goals, here’s a closer look at immediate and deferred annuities. And, this can help you answer one of the most important questions you’ll have about an annuity; money for today or the rest of your life?

Immediate Annuities

As you probably correctly assumed, with immediate annuities you can start receiving payments soon after you make your initial investment. Usually, this is within 12 months after you’ve purchased your premium. Because this annuity is bought with one lump sum payment — it is technically a single premium immediate annuity (SPIA). But, that’s splitting hairs. 

Despite the fact that rates are relatively low, immediate annuities are often used to cover essential living expenses that you probably can’t cover with Social Security or a pension. Immediate annuities also come with the following pros;

  • Protection against outliving your savings.
  • Being allowed to add your spouse so that they’ll continue to receive payouts after you pass.
  • It has a simple structure that makes it easier to understand and plan your retirement.
  • Your savings are protected from the market since your savings actually aren’t in the market.
  • Provides you with a pre-determined revenue stream since these are more like paychecks as opposed to savings.

There are some drawbacks as well. Mainly, they won’t grow with any market upside making it not viable if you’re looking to invest. Moreover, immediate annuities aren’t as flexible. And, you don’t have as much control over withdrawals.

When an Immediate Annuity Makes Sense

You’re interested in this type of annuity, you should ask the following questions to make sure it’s right for you and your retirement plan. 

Do I need more income right now?

Let’s say that you’ve crunched the numbers and worked with a financial advisor. You then determine that you are going to need a supplemental income sooner or later. Then, an immediate annuity makes a lot of sense. 

But, what if you don’t need more income until you get further into retirement? For example, you can wait to withdrawal your annuity seven years from now. If so, buying a deferred annuity is the better option. And, as an added perk, you’ll get seven more years of tax-deferred compounding. As a result, you’ll receive bigger payments. 

Alternatively, you could purchase a product like a five-year fixed-rate deferred annuity. This would guarantee a set interest rate for the next five years. That makes it similar to a certificate of deposit. But, you then have the option to convert this into an immediate annuity after five years. 

How long do I need income?

The main selling point with an annuity is that you’ll have a guaranteed lifetime income. However, that’s not applicable to everyone. In some cases, you may only need an annuity for a specific window of time. 

For example, let’s say that you’re recently retired at age 62. But, you want to delay taking Social Security for another eight years to let your benefit continue to accumulate. Another advantage of delaying your Social Security benefits is that you can earn a “delayed retirement” credit.

“For example, say you were born in 1951 and your full retirement age is 66,” writes Rob Williams for Charles Schwab. “If you started your benefits at age 68, you would receive a credit of 8% per year multiplied by two (the number of years you waited). This makes your benefit 16% higher than the amount you would have received at age 66. (This doesn’t include any potential additional cost of living adjustments for inflation from 66-68).”

If this sounds appealing, you could buy an eight-year period-certain annuity. This will cover your income gap until you claim your benefits. 

How can I benefit from this particular annuity?

Before committing to an annuity, you want to make sure that it will meet your specific financial goals. Some of the most important considerations include;

  • Does the immediate annuity provide the payout that you’re seeking? 
  • Will it help you achieve the income goals that you’ve set? 
  • Will it cover your spouse? 

Will my payments decrease if the financial markets go down?

Short answer, no. 

While an immediate annuity does guarantee that your payments will never change, regardless of the performance of stock or bond markets, your income payments are locked in with Due. 

With that in mind. If inflation is a concern, you can always add a Cost of Living Adjustment (COLA) rider. You’ll tack this on when you purchase your annuity. And, this rider will increase your annuity income amount by a fixed percentage annually. Usually, this is in the 1%-4% range. 

Just note that a COLA rider addition will reduce the amount you’ll receive from your initial income payments. 

How soon can I begin receiving my income payments?

Again, as the name implies, your payments will begin immediately after you’ve deposited your funds into the annuity. Typically, you can expect your first income payment one month after the annuity’s been issued. 

What if you don’t need the income right away? You do have the ability to delay payments for up to one year.

How will my income payments be taxed?

It depends on the money source that you used to make the annuity deposit.

For example, you purchased the annuity with tax-qualified funds, such as those from a traditional IRA or a 401(k). You will have to pay taxes on the entire amount of your monthly payment. The reason for this is that none of this money has been taxed yet. And, Uncle Sam thinks that it’s only fair for him to get his slice of the pie at this time since he gave you a deduction for contributing the money.

What if you used nonqualified funds? Examples could be from checking, savings, CDs, or other nonqualified investments. Since this money has already been taxed. That means that only a part of your annuity income payment will be taxed when you begin receiving payments. 

Additionally, a portion of each income payment from the annuity will be considered earnings — which will be taxed as income. And a portion of this will also be considered a return of principal — which will be tax-free. The tax-free portion is usually larger.

How large will my income payments be?

It depends on factors like your age and gender. It’s also based on which insurer issues the annuity. 

So, let’s say that you purchase a $200,000 premium deposit with nonqualified funds. For a single male, age 67, you’ll receive a monthly lifetime income of $1,054.72. This will include $148.72 of taxable income, as well as $906.00 of nontaxable income. When you reach 85, after 18.4 years, you will have recouped your initial premium deposit. Moreover, payments would become fully taxable.

For joint life payout for a 67-year-old male and female, the monthly lifetime income payment will be $875.80. $157.64 of this is taxable; $718.16 nontaxable. If you make it to age 90, after 23.2 years, you’ll have recouped the initial premium deposit. And, payments are fully taxable.

What happens to my money if I pass away prematurely?

Immediate annuities can include a cash-refund feature. This promises that if you pass away unexpectedly, and haven’t received your first deposit back, your premium payment will not be lost.

In other words, if you pass away before your monthly income payments come out to the full amount of your annuity purchase price, the difference will go to your named beneficiary. For instance, you deposited $100,000 into the annuity and you received $50,000 in monthly income payments prior to passing away. Your beneficiary would receive the remaining $50,000 tax-free — as long as you used post-tax funds to buy the annuity.

It’s normal for most people to choose this option. Be aware that this will reduce your monthly payments. But, if leaving an inheritance isn’t a priority, you don’t have to select this option. 

Is there a limit to how many income payments you can receive?

If you choose the lifetime-income option, then there is no limit to the number of income payments that you’ll receive. Again, this is the primary reason why you buy an annuity. Regardless of how long you live, you will be guaranteed to receive your fixed monthly income.

What about the joint income option. In this case, your spouse or another income recipient will receive the regular monthly income payments for the remainder of their lives. However, monthly payments will be smaller than those from a single life plan.

Deferred Annuities

With a deferred annuity, you’re investing your money and then taking it out at a later date. In other words, you’re paying a premium to the annuity. You then choose from the available investment options.

After you’ve settled on your investment option, your earnings will accumulate on a tax-deferred basis. And, unlike immediate annuities, you have much more flexibility. In fact, you can determine when to start the distribution, income, and phase at a later date — this is usually around when you retire.

Now, before you impulsively purchase a deferred annuity, you need to be aware of the fact there are actually three types of deferred annuities.

Fixed annuities.

These provide you with a fixed rate of return. The catch? It’s only for a specified period of time. However, you select that timeframe. Ideally, it should be one based on how much you need during retirement and your income needs.

Variable annuities.

Variable annuities come with a plethora of professionally managed investment options. Because of this, the value of the annuity contract is determined by the performance of the underlying investment options (also called sub-accounts) that you chose. That also means they can fluctuate. Additionally, you can add on an optional living benefit rider — for an additional cost of course. It provides a guaranteed lifetime income, no matter how the annuity’s investments are fairing.

Indexed annuities.

Indexed annuities are considered a better option if you’re seeking investment growth. In this case, through any returns associated with the performance of market indices, such as the S&P 500. Note that this will take place over a variety of time horizons and provides 100% principal protection from the insurance company.

However, gains linked to the annuity are capped in order to offset this protection. As a consequence, growth may be less than what the actual market gains were achieved by the index. Fixed indexed annuities are also similar to variable annuities in that you have the option to throw in lifetime income benefits.

Also, you can convert your deferred annuities into immediate annuities — if you are in need of cash right now. Furthermore, both can be either fixed or variable. And, they each come with fees and expenses. That means payouts made from your contributions will have those costs subtracted.

When a Deferred Annuity Makes Sense

“Conventional financial wisdom says people should only purchase annuities shortly after they retire, around ages 65-75. But, conventional wisdom may not be right for everyone,” says Ed Hochard, The Annuity Shop. And, he’s 100% right 

“In general, people tend to purchase an annuity product at retirement time or less than a year after they quit working,” he adds. “One reason for waiting is that it has probably taken a person a long time to save the money necessary to purchase an annuity.” Also, a lot of people are concerned “about purchasing an annuity before retiring is the lack of liquidity.”

“Younger investors often feel an annuity will tie up their money for too long and give them less money for maintaining a good life in retirement,” states Hochard. “Additionally, some pre-retirees worry about fees that some types of annuities charge that could deplete a person’s savings faster than anticipated.”

While there is no “perfect” age for purchasing an annuity, it does make sense for younger individuals to add an annuity to their portfolio. “Multiple surveys of annuity contracts indicate the median age for purchasing the first annuity is not 65 but 52,” he states. “A lot of first purchasers, in fact, are under the age of 50. However, some financial advisors believe that the mid to late 40s may be the sweet spot for benefiting from an annuity.”

If you’re a millennial buried under debt, you might refute this theory. However, some experts believe that when you’re in your 40’s, you “have fewer external demands on their earnings at that age, such as paying for college tuition, weddings, or helping a child purchase a home. Fewer bills to pay, albeit for a small window of time, means that many 40-somethings can afford an annuity.”

But, that’s just the tip of the iceberg. Many younger people are investing in annuities because;

  • People are living longer. It’s projected that by 2050, longevity in the United States will rise higher than 93 years old. As such, a guaranteed lifetime income is more important than ever.
  • With people living longer, means rising health care costs. In 2019, health spending by 4.6% $3.8 trillion or $11,582 per capita.
  • There remains uncertainty regarding the economy and stock market following two market crashes (2000-2002 and 2007-2009), as well as the fallout from the pandemic. 
  • The future of Social Security remains uncertain. While it’s unlikely that Social Security will become completely depleted, benefits may not be as much. 
  • You’re allowed to invest up to 25% of your IRA or 401(k) plan (or $125,000, whichever is less) in a deferred-income annuity or Qualified Longevity Annuity. As a result, you do not have to take the required minimum distributions when you turn 70½. And, since you can delay payments until age 85, you don’t have to pay taxes until then. 

And, annuities can help you plan “backward.”

“Most planners advise people to stay on a traditional path of savings, debt reduction, and growth, followed by the spend-down phase of life. However, it seems that building streams of guaranteed income might be a strategy one should start sooner rather than later,” explains Hochard. “Knowing that you have at least one source of guaranteed income that you can’t outlive in the form of an annuity may give you more confidence when you invest, increase your risk tolerance, and ultimately increase savings.”

Choosing your annuity. 

Even though deferred annuities are enticing, especially among younger people, there is a major drawback They can tie up your investment for years — if not decades. What’s more, deferred annuities also charge high fees and commissions. As such, this type of annuity may not the best option for super savers. 

Rather, you may want to invest in a 401(k) or IRA. It’s also worth exploring an HSA if you’re qualified to contribute to such an account. However, if you’ve maxed out their contribution limits for the tax-advantaged retirement accounts that are available to you, and you have the finances, a deferred annuity is worth the investment. In addition to providing a guaranteed lifetime income, you can also delay paying taxes on this income at a later date. 

On the other hand, if you’re approaching retirement or have already retired, the window for the accumulation phase is much smaller. Therefore, an immediate annuity has a lot of upsides. At the top of the list, it allows you to lock in a retirement income for the rest of your life. 

Furthermore, if you put retirement savings towards buying an immediate annuity you have less to worry about. Primarily, being concerned about the future of your investments or if the economy goes through a rough patch. And, immediate annuities can be an excellent way to convert a lump-sum payment into a supplemental income along with a 401(k) or pension distribution.

Whichever option you choose, always double-check your annuity contract. The last thing you want is unpleasant surprises that may throw a monkey wrench into your retirement plan. At the minimum, make sure that you clearly understand all the fees involved with the contract. It’s also in your best interest to compare them with a couple of other annuities to make sure that they’re not exorbitant. 

If you still have questions about choosing money for today or the rest of your life, speak with a financial advisor.

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