1. Single-premium fixed immediate/deferred annuities. These products are purchased with a lump sum of money and offer a guaranteed source of income for retirement, but once purchased, they have substantial surrender fees for liquidation.
An immediate annuity, also known as a single-premium immediate annuity (SPIA), begins paying out income immediately after you have purchased it with a single, lump-sum investment. A deferred immediate annuity, also known as a single premium deferred annuity (SPDA), provides an accumulation period until it begins paying out income at a future date after you have purchased it with a single, lump-sum investment.
Individuals approaching retirement age may choose these types of annuities because they allow seniors to supplement Social Security income and pension plans that might not provide enough income to cover basic retirement-living expenses.
Immediate annuities can provide periodic lifetime payments or payments for a fixed period of time or for you (and your spouse if you wish), depending on which options you choose. If the immediate annuity is nonqualified, meaning you have purchased it with after-tax dollars, only the earnings will be subject to income tax, which you must pay each year at your ordinary rate. It is rarely a good idea to use qualified — individual retirement account or 401(k) plan — money to purchase a fixed annuity.
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- Safety: As with any annuity, your risk can be transferred to the insurance company. If the immediate annuity is fixed, your premium goes into the company's general fund to be invested in bonds and stocks, and the interest rate cannot go below a certain minimum. Also, every state has an insurance guaranty association that offers backup protection in the unlikely event the insurance company that sold you your annuity cannot honor its obligations.
- Tax-deferred growth: The income payments for non-qualified immediate annuities are based on a combination of principal returns, which are not taxed, and payout of income, which is taxed at income tax rates.
- Mortality credits: Risk pooling, or the spreading of risk across many accounts, allows premiums from annuity owners who die prematurely to be used to pay benefits for those who live beyond their life expectancy. These mortality credits can help increase your returns above those of other investment options and, by choosing a lifetime benefit option, you can hedge against ever outliving your available assets. In fact, depending upon how long you live, your annuity can actually pay you more money than you originally invested plus what your account has earned in interest or capital gains.
- Loss of control: The most significant drawback is that immediate annuities are irrevocable. Once your lump-sum payment has been exchanged for periodic distributions, you no longer have control of or access to your money. That means funds may not be available for emergencies or any other use.
- Loss of purchasing power: If your annuity has a fixed rate of interest that is lower than the rate of inflation, your money is not working for your benefit.
- Expenses: All annuities carry fees, commissions and administrative charges that are usually higher than those that accompany other investments.
You should always make sure the insurance company that issues your annuity is highly rated by any of the financial institution rating agencies, such as Moody's, Fitch, Standard & Poor's or A.M. Best.