An immediate annuity is a straightforward contract between you and an insurance company that can help provide financial security or complement your investment portfolio. You make one large, lump-sum payment to the insurer, and in return, you’ll receive a guaranteed income stream from that payment. You can set up your annuity to pay you for a certain number of years, or for the rest of your life.
What makes immediate annuities unique is how quickly you start receiving payments. With other types of annuities, you’ll make a lump-sum payment or pay premiums over a period of time, but won’t start receiving an income for several years. An immediate annuity can start paying you right away — within 30 days of purchase, although you can delay the start of your payments for up to 12 months, if you prefer.
What is an immediate annuity?
An immediate annuity is an insurance contract between you and an insurance company that provides immediate payments in exchange for a large, up-front premium. You’ll also have the option to wait up to 12 months to start receiving annuity payments, instead of right away.
Your annuity will grow with interest based on the type of contract you choose, and if you purchase the annuity with money that has already been taxed, you’ll only pay taxes on the interest you've gained when you begin to receive income payments. [1]
Immediate annuities are best for people who have a large sum of money and want to use that money to set up an income stream, such as new retirees looking to manage their retirement savings.
How do immediate annuities work?
Immediate annuities offer unique features compared to other annuities, especially when it comes to how you fund the annuity — and how the payments are distributed back to you.
Premiums
With an immediate annuity, you’ll usually make one up-front premium payment to fund the annuity — although some immediate annuities allow you to contribute additional premiums as long as they’re made within the first year of the contract. People often use money from their 401(k) or IRA to pay this up-front premium — but you can use other savings, proceeds from a large sale, or even lottery winnings, to fund an immediate annuity.
Accumulation period
A defining feature of immediate annuities is that they don’t have an accumulation period. For deferred annuities, the accumulation period is the time between when you fund your annuity and when you start receiving income payments from it. With an immediate annuity, your payouts can begin right away.
Annuitization or payout phase
Annuitization describes how your annuity pays out once your contract has been funded. With an immediate annuity, since the contract is usually funded by a lump-sum premium payment, you’ll start receiving an income from your annuity right away.
You can set up your annuity to pay out for a set number of years; this type of annuity is sometimes called immediate term annuity. Alternatively, you can set your contract up as an immediate lifetime annuity, which lasts for the rest of your life, no matter how long you live.
Surrender period
If you cancel your annuity or take a withdrawal for an amount larger than what’s allowed by your contract during the surrender period, you’ll have to pay a penalty fee. But with immediate annuities, there generally isn’t a surrender period, because you’ll start receiving the payouts for your annuity right away, according to your agreed-upon pay schedule.
Since immediate annuities are purchased to provide income, they usually can’t be “surrendered” — so you won’t have to pay a fee. [2] Other types of annuities, like deferred annuities, may allow you to withdraw part of the principal for a fee.
Fees & penalties
Because you can’t begin withdrawing money "too soon" from an immediate annuity, you won’t encounter the fees or penalties you might with a deferred annuity (unless you agreed to begin withdrawals up to 12 months later in your contract, and unexpectedly needed to access your funds sooner).
Guarantees & riders
Not all immediate annuities come with a guaranteed rate of growth. A fixed immediate annuity does, but the growth of indexed and variable immediate annuities are tied to the market, albeit with performance caps and floors to prevent you from gaining or losing too much money.
You can also add riders to your annuity. Riders are add-ons to your contract that can offer your certain guarantees. You can usually add a rider for an extra fee.
“A ‘cash refund’ rider is one of the most common immediate annuity riders available,” says Daniel Masuda Lehrman, a certified financial planner at Masuda Lehrman Wealth. Cash refund riders allow your chosen beneficiaries to inherit any unpaid principal if you die before the payout period ends. This ensures that when you die, your loved ones will at least receive whatever’s left from the initial principal you paid for the annuity.
Tax implications
With immediate annuities, you won’t be responsible for paying taxes on the money you put in. This amount is called the principal. When your annuity pays you back in the form of a regular income stream, you’ll only be taxed on the growth if you purchased your annuity with pre-tax dollars — for example, with funds held in a 401(k) plan or IRA. [3]
Learn more about qualified annuities
What are the different types of immediate annuities?
There are different types of immediate annuities, mostly depending on how your principal is invested.
What is single-premium immediate annuity (SPIA)?
A single-premium immediate annuity (SPIA) is a term that applies to nearly all immediate annuities. You’ll pay a single premium to set up the annuity, and your income starts right away — or within 12 months.
People often set up SPIAs after they sell an asset, like real estate or stocks, or following a financial windfall. [4]
What is a fixed immediate annuity?
Fixed immediate annuities are a straightforward annuity contract where your funds grow at fixed interest rate set by the insurance company. You know exactly how much you’ll pay, how fast your policy will grow, and the size of the income payments you'll receive.
While your rate of growth is guaranteed, you’ll forfeit the chance to have more lucrative growth through other types of annuities. But if you want to take a conservative approach to investing and are risk-averse, a fixed immediate annuity can be a good fit for you.
What is an indexed immediate annuity?
An indexed immediate annuity is unique in how the funds grow. Instead of having a fixed rate of return, your annuity will be tied to the performance of a market index — for example, the S&P 500. When the market does well, your payments will increase, and when the market underperforms, your payments may decrease.
What is a variable immediate annuity?
A variable immediate annuity is like an indexed immediate annuity except you’ll get to decide where your principal is invested. This option can be great if you’re familiar with stocks, bonds, and mutual funds, and willing to take more risk with the growth rate of your annuity — but unlike fixed and indexed annuities, your principal may lose value if the market underperforms.
Learn more about other types of annuities
What are the pros & cons of immediate annuities?
Immediate annuities offer the peace of mind and financial security that comes with immediate access to a guaranteed income, but beyond your scheduled income payments, you’ll lose access to the rest of your invested funds in case of an emergency, and, depending on the investment option you choose, you may get lower returns compared to other investment products.
Pros
Creates an immediate stream of income. Once you set up your immediate annuity, you’ll start benefiting from your income stream right away. Depending on the terms of your contract, this could mean securing a source of income for life.
Protection against market changes. Your annuity is protected from losing value if you opt for a fixed immediate annuity, so you don’t have to worry about any downturns in the market like you would with stocks and bonds.
Simple and predictable. You know exactly what your annuity will cost, when you’ll get paid, and, in most cases, how much. Setting up an immediate annuity takes minimal effort to manage and gives you a reliable income.
Cons
You’ll give up liquidity. Once you purchase your annuity, you’ll only be able to access the money based on the payment schedule you set up. If an emergency happens and you need a large sum of money, you won’t be able to get it from your annuity without incurring steep fees.
Your income payments will likely not adjust for inflation. As inflation rises, your income will stay the same, especially if you bought a fixed immediate annuity. A potential solution to this would be to add a cost of living adjustment rider (COLA) to your contract, which increases the amount of your annuity payments over time to help keep up with inflation.
Low interest rates. While you can depend on an annuity for predictable growth, especially if you choose a fixed annuity, you’re also giving up growth potential because fixed and indexed annuities accumulate interest at a lower rate than other tools, like stocks or bonds. If you’re interested in an annuity and invest in the market at the same time, you may consider an immediate variable annuity.
What should you consider before buying an immediate annuity?
Annuities are a good financial tool for many people, but they’re not for everyone. Consider factors like your age, investment goals, and risk tolerance before you purchase an immediate annuity.
Your age
For most people, setting up an immediate annuity is usually a better fit after you reach retirement age. Depending on how long you want your annuity to last or how much you need to receive on a regular basis, it may even make sense for you to wait until you’re 70 or 75, especially if you want an annuity that provides payments for the rest of your life.
Your investment goals
An immediate annuity can be considered a good investment only if it aligns with your financial goals. If your top priority is to create an immediate stream of income, it can be a good fit.
However, if your goal is to aggressively grow your savings over a period of time, other investment vehicles, including other types of annuities, may be a better fit. The longer you can wait to start receiving annuity payments, the more you’ll allow the money on your contract to grow. If you can wait longer, consider exploring a deferred annuity instead, which start making payments several years after the purchase of your contract, and after your funds have had time to grow.
Your risk tolerance
Fixed and indexed immediate annuities offer low risk compared to other investment options. If you’re risk-averse and want to have a high degree of confidence about how your investments will grow, these types of annuities can be a good fit. But if you’re more open to risk and want potential access to higher returns, you’ll be better off investing in a variable annuity.
Who should consider an immediate annuity?
If you have a large sum of money and want to set up a steady income stream right away, an immediate annuity could be a good fit for you. Annuities are especially helpful if you want to manage your money in a way that involves limited administrative oversight.
People who usually fit this description are retirees who want to organize their retirement accounts to distribute their savings in a sustainable way. “These are clients without other sources of guaranteed income,” says Kyle Newell, owner of Newell Wealth Management and a certified financial planner. “Typically [immediate annuities] are used to help cover a portion of basic needs and so you don't have to worry about market fluctuations.”
