Jane is all set to retire in a month’s time. She is aware that her CD is maturing a day before her retirement. Jane decides to reinvest the entire amount in an instrument that will provide with a regular stream of income as well as protects her savings. In short, she wants a low risk option that will provide her with a regular stream of decent income. Jane consults a financial planner, who recommends her to invest in immediate annuities.
Immediate annuities requires the annuitant to make a lump sum contribution and the annuitant starts receiving the income almost immediately after entering into a contract with the insurance company He is also provided with an option to receive the income for a fixed period or for life.
Advantages of Immediate Annuities
- Regular stream of income: Immediate annuities are a good source to earn a regular income, especially when one is not having a regular source of income. Take for instance retired people. Opting for an immediate annuity will allow them to receive a check of fixed amount on a set date. This will also help them to plan their expenses.
- Benefit of exclusion ratio: Exclusion ratio refers to that amount of annuity, which is not taxed as it is deemed a repayment of the principal amount. Hence, only the interest is taxed. Thus, immediate annuities attract lower tax compared to other investment options such as IRAs and 401k.
- Protection from creditors: Immediate annuities provides with an income, even during financial hardship. Many states in the US offer your immediate annuity, a protection from attachment by creditors. Hence, immediate annuities can prove to be a good option when one becomes bankrupt.
- Better returns: At a time, when interest rates are spiraling downwards and income from other fixed deposit avenues are shrinking, immediate annuities continue to offer attractive rates. For instance, a report from the Los Angeles Times states that ‘the average yield on tax-free money market funds has fallen to 1.87%, according to IMoneyNet.com, the lowest level in seven years.’ On the other hand, immediate annuity presents guaranteed returns of 3% to 6%. Hence, many people are opting for immediate annuities to park their funds.
Disadvantages of Immediate Annuities
- Fair returns: The returns generated by immediate annuities are less when compared with the returns given by stocks. Hence, immediate annuity will not be a good option, for investors who are looking for high returns.
- Inflation: Traditionally, inflation has always eroded the value of income received from fixed return investments. And immediate annuity is not an exception.
- Double-edged: Immediate annuities are double edged. If the annuitant opts for a ‘life income’ option, the insurance company will be under an obligation to pay income for the rest of his life. However, if he dies within a month of buying an immediate annuity plan, the insurance company will pocket the entire contribution and his heirs will not get a single dime.
Thus, there are many advantages and disadvantages associated with immediate annuities and one must carefully weigh them before investing in immediate annuities.