What is an immediate annuity? Benefits, risks and how they work

An immediate annuity is a financial product sold by insurance companies that allows you to convert a lump sum of money into a stream of guaranteed income payments. 

Most people who purchase immediate annuities are approaching or already in retirement. They’re looking for a reliable supplement to other income sources, like Social Security or a pension, that they can’t outlive. 

Payments can last for a set period of time or for your lifetime. You can start receiving payments almost immediately after signing your annuity contract. 

Immediate annuities tend to be the simplest and most straightforward type of annuity. This can reduce fees, which might make them a more affordable option than other types of annuities. 

How immediate annuities work

An immediate annuity is essentially a contract between you and an insurance company. You provide the insurer with a lump sum of money, and in return, the company agrees to pay you a set amount of income for a specified period or for the rest of your life. 

A single-premium immediate annuity (SPIA) is the simplest and most common type of immediate annuity, and it’s what people usually mean when they reference immediate annuities. The defining feature of SPIAs is that they’re funded with a single (and usually quite large) payment to the insurer. 

Immediate annuities are the opposite of deferred annuities. As the name implies, deferred annuity payouts from the insurer are delayed for years, sometimes even decades. This gives you the option to fund a deferred annuity contract over time, instead of all at once with a single lump-sum the way immediate annuities require. 

The amount of income you receive from an immediate annuity depends on several factors, including:

• The size of your lump-sum premium: The more money you put into your annuity contract, the higher your monthly payments will be. For example, a $100,000 premium on an immediate annuity may only generate $6,000 to $10,500 a year in lifetime payments, depending on how old you are when you sign your contract. 
• Your age: Generally, younger people receive lower income payments compared to older people because their life expectancy is longer, so payments need to last longer.
• The type of annuity you choose: Fixed annuity returns are tied to interest rates while variable annuity returns are based on the performance of underlying investments. 

Types of immediate annuities 

The term “immediate” simply describes when you’ll start receiving payments from the insurance company. It doesn’t describe your annuity’s rate of return. That’s why immediate annuities are divided further into three types: fixed, variable and indexed. 

1. Fixed immediate annuity: With the simplest type of annuity, you’ll receive a guaranteed income stream based on a fixed interest rate set at the time of purchase. The payout amount remains constant throughout the time specified in your contract. While fixed annuities offer the most predictable income stream, you run the risk of losing purchasing power over time due to inflation. Most single premium immediate annuities are fixed. 
2. Variable immediate annuity: This annuity invests your principal amount in sub-accounts similar to mutual funds. The income stream you receive is based on the underlying investment performance of the sub-accounts, so your payout can fluctuate depending on the market. While there’s the potential for higher returns compared to fixed annuities, the trade-off is higher fees, more complexity and less predictability. 
3. Indexed immediate annuities: This annuity’s income stream is based on a fixed interest rate with the potential for growth linked to a stock market index, such as the S&P 500. While there’s the possibility for higher income compared to a fixed annuity if the linked index performs well, the growth potential is usually capped, limiting the upside compared to investing directly in one of the best index funds. 

While indexed and variable annuities are sometimes touted as ways to potentially boost your returns, it’s important to keep in mind that they add complexity and cost to your contract. 

When interest rates are higher, fixed annuities can be a more attractive option. They tend to earn slightly better rates than certificates of deposit, but you can lock in the rate on an annuity for much longer. In April 2024, the best fixed annuity rates from top insurers ranged from roughly 5.6 percent to 6.8 percent — not bad for a lifetime fixed rate of return. 

Other ways to classify immediate annuities 

Immediate annuities can also be classified based on who receives payments and for how long. Here are a few examples. 

• Single life: You receive guaranteed income payments for the rest of your life, but there’s no death benefit for your heirs after you die unless you purchase an additional death benefit rider. 
• Joint life: Payments are made until both annuitants (usually you and a spouse) pass away. The income stream is lower than a single life annuity because of the longer expected payout period (the insurer generally expects both spouses to live a long life). Some joint life annuities offer a survivor benefit, which increases the payout to the surviving spouse after one partner dies.
• Period certain: This annuity guarantees payments for a set period of time, such as 10 or 20 years, instead of the rest of your life. If you pass away before the period is over, a beneficiary will continue receiving annuity payments until the specified number of years ends.

While many people think of annuities as a way to guarantee income for life, there’s ways to strategically use them for a shorter time, too. 

For example, if someone plans to retire at age 64, but wants to delay collecting Social Security until age 70 in order to maximize their benefits, that person could purchase a 6-year fixed immediate annuity using a portion of their retirement savings and create a financial bridge of guaranteed income until Social Security kicks in. 

Benefits of immediate annuities 

Creating lifetime payments in retirement is the most obvious advantage of immediate annuities, but they can provide other benefits, too. 

• Guaranteed income: Unlike traditional investments that can fluctuate in value, immediate annuities provide a stream of income that you can’t outlive. 
• Potential tax advantages: The income generated from an immediate annuity may be partially tax-deferred, meaning you don’t pay taxes on the earnings until you start receiving payments. 
• Simplified income management: Immediate annuities can simplify retirement planning by providing a consistent, automatic income stream. If you hate the idea of actively managing your investments or worry about withdrawing too much money too quickly from your retirement nest egg, immediate annuities can offer some peace of mind. 

Drawbacks of immediate annuities

While immediate annuities offer attractive features for certain retirees, they’re not right for everyone. Perhaps the biggest drawback of single-premium immediate annuities is they’re generally irrevocable, which means you can’t surrender the contract and get your money back. 

• Loss of access to principal: Once you invest in an immediate annuity, you typically can’t access your principal investment. This can limit your flexibility if you have unexpected expenses in retirement.
• Lower overall returns: Immediate annuities tend to offer lower returns than stocks and bonds. This can be a disadvantage if you’re concerned about inflation eroding your purchasing power.
• Large upfront premium: You’ll likely need at least $50,000 to $100,000 to adequately fund an immediate annuity. Otherwise your lifetime payments from the insurance company will be rather small. 

What to consider before buying an immediate annuity

If you’re considering purchasing an immediate annuity, it’s important to do your research. Annuities are complex agreements that are notoriously difficult — if not impossible — to alter later, so you want to ensure you pick a reputable company that offers you attractive terms. 

Get quotes from several insurers so you can compare rates, features and terms. Many insurance companies offer online quote tools which can show you current annuity rates based on your age, desired payout options and your lump-sum investment. However, the most accurate way to get current rates for specific annuity products is by contacting individual insurance companies directly. 

High rates aren’t everything. When shopping around, also consider factors like payout options (lifetime vs. fixed period), cost-of-living adjustment provisions and the financial strength and reputation of the insurance company itself. 

Before signing an annuity contract, make sure you fully understand what you’re buying, its potential return and any fees or commission baked into the agreement. Gain clarity on payout options, surrender charges and any limits on accessing your principal.

Finally, you might consider working with a financial advisor who can evaluate your retirement needs and determine if an immediate makes sense for you. An advisor can also read through your annuity contract before you sign, helping you decipher any ambiguity before you enter the agreement. 

Bottom line

Immediate annuities can be a valuable tool for people seeking guaranteed income and peace of mind in retirement. However, they are not a one-size-fits-all solution. Carefully consider your retirement needs, risk tolerance and financial goals before purchasing an immediate annuity.