Immediate Annuities

This may sound great on the surface, but it may not make financial sense depending on your goals and financial situation. These products often bear internal rates of return lower than competing investment options, but the same is frequently true of their variable and fixed annuity counterparts.

Should You Consider an Immediate Annuity?

Generally speaking, immediate annuities are straightforward and easy to understand compared with other types of annuities. If you haven’t heard of SPIAs, it could be because these contracts usually aren’t as profitable for insurance companies or their sales people as other annuity types may be. Instead, insurance agents and advisers may be more inclined to sell annuities with added features that carry steeper costs and can generate higher commissions.

Since annuities are a form of income, payments may be subject to ordinary income tax rates instead of the generally lower capital gains tax rates—an important consideration with annuity income. Immediate annuities also have other important risks to consider, especially for investors who plan on using them as a form of retirement income.

Risks of Immediate Annuities

Before you purchase an immediate annuity, consider these potential drawbacks.

The Effect of Inflation

In many cases, an immediate annuity’s payout is fixed and not adjusted for inflation. The effect of inflation could materially reduce the purchasing power of those income payments over long periods of time. The longer the payouts continue, the less value they might offer.

Since 1925, inflation has averaged about 3% per year¹., meaning the cost of living increases over time. As an illustration, if you currently require $50,000 annually to cover your expenses, you would need $67,000 in 10 years, over $90,000 in 20 years and over $120,000 in 30 years. An immediate annuity would begin providing a return on investment potentially greater than that of cash, but interest rates of close to or less than 3% can leave annuity investors in the red in the long term.

This could also work against investors who may require more long-term investment growth than they had anticipated.

Opportunity Cost

Investors focused on the peace of mind that an immediate annuity could provide may be overlooking the benefits they are forgoing by not investing in the market—often known as an opportunity cost. If portfolio growth is one of your objectives or you end up needing more long-term growth than you expected, there are likely better options available than immediate annuities. While insurance salespeople may tout annuities as low-risk relative to stocks, in our view, an often-overlooked risk is the missing out on the growth available from other investment options.

Illiquidity

When you invest in annuity, you may be taking on the risk of being unable to convert your investment into cash at all or without significant costs—also called liquidity risk. This could be a problem in times of emergency or if something unexpected comes up and you need quick access to cash.

Other Considerations

Even though immediate annuities may be more straightforward than other types of annuities, there are still many factors to consider before purchasing one. When determining if an immediate annuity is appropriate for you, you should consider how long you need your money to last. If you elect to receive lifetime payouts, your payments would generally stop when you pass—leaving the remainder of your money with the insurance company. Your benefits are often tied to your longevity or that of your spouse.

Fisher Investments May Be Able to Evaluate Your Immediate Annuity

Ultimately, the most important outcome is for you to reach your long-term investing goals. Before committing yourself to an immediate annuity, it is important to understand how they work and how they fit into your overall financial plan.

Fisher Investments offers an Annuity Evaluation Program for qualified investors with at least $500,000 in investible assets. Our professional Annuity Counselors will help you understand the terms of your annuity contracts and how they fit in with your financial goals.

¹Source: Global Financial Data, Inc. as of 01/09/2018. Based on BLS Consumer Price Index from 1925–2017.