Immediate (Lifetime Income) vs. Deferred AnnuitiesJanuary 1st, 2013 by David Waring
Immediate annuities are commonly associated with the notion of a lifetime revenue stream, and some do provide this benefit. It is important to understand however that while all immediate annuities provide an income stream (a consistent, periodic distribution of cash), they can be for life or for other fixed periods of time.
A deferred annuity can be thought of as providing a lump-sum payment at a future date. Many people convert their deferred annuity to an immediate annuity when they are ready to retire and live of their investments.
Can you get an income until you die from an immediate annuity? Yes, you can. In this case, you would want an immediate annuity with “Lifetime Withdrawal Benefits”.
Depending on the type of immediate annuity (fixed or variable), the amount that you receive with an immediate annuity will be either a steady amount, or change from one month to another. Generally speaking with this type of annuity, you make one relatively large lump sum payment at the beginning. Once you have made your initial investment, you can choose to start taking money immediately, or have the payment begin at a specific date in the future less than one year away from your first payment.
Unlike any other type of annuity, the payout on an immediate annuity with Lifetime Withdrawal Benefits is heavily dependent on your age and gender. The annuity provider is making a guess on how long you will live, and therefore how long they will have to make payments. If you are in good health and have a history of long life in your family, an immediate annuity with lifetime withdrawal benefits might make sense. The lifetime withdrawal benefit can be bought for one individual or married couple. In the case of the married couple, the income would continue even when one person died.
Do you have to buy an immediate annuity with lifetime withdrawal benefits?
No. An immediate annuity is for anyone that wants to receive a regular (generally monthly or quarterly) income stream during their retirement. When buying the annuity you set term over which you would like to receive distributions, usually ranging from 5 to 20 twenty years.
There are significant tax differences between immediate annuities and deferred annuities. A portion of the distributions for an immediate annuity are considered re-payment of principal and, as result, not subject to income tax. You can learn more about the taxes on annuities here.
With a deferred annuity, there are no automatic distributions. Furthermore, you will have to wait a number of years before you are able to make large withdrawals from the annuity without paying a significant penalty (learn more about early withdrawal penalties here). The waiting period is anywhere from 3 to 10 years, depending on the specific annuity you choose, and during this period your money accumulates and grows without paying taxes (You don’t pay taxes until you start withdrawing money). At the end of the waiting period, you have several options:
- Withdraw your money. This will generate an immediate tax consequence.
- Make a tax-free transfer into a new annuity.
- Turn your deferred annuity into an immediate annuity. This is called “annuitization”.
Immediate Annuities are designed for retired individuals that want to receive a regular income stream. If you have a major concern about outliving your savings, an immediate annuity with Lifetime Withdrawal Benefits can provide peace of mind. On the other hand, the main benefit of annuities, the ability to defer taxes, is much greater with a deferred annuity. If you are more than a couple years from retirement, a deferred annuity is most likely a superior choice in relation to an immediate annuity.