Why Buy Fixed Over Immediate

The decision as to which kind of annuity, fixed or immediate, to purchase is based largely on the specific need or goal that needs to be fulfilled.  In certain situations, a combination of both could provide the right solution. The answer, in any case, requires an understanding of the individual’s financial situation including goals, timeframes and liquidity needs.

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Immediate Annuity

Immediate annuities have one simple purpose and that is to convert a lump sum of money into a stream of income for a predetermined period of time or for the life of the annuitant. As a retirement income vehicle they hold some significant advantages over other alternatives.  The overriding advantage is that it is the only investment vehicle that can provide a guaranteed income that you cannot outlive. 

Once the asset is annuitized – converted into a guaranteed stream of income – it is unavailable for any other purpose.  The annuity pay out rate is determined by calculating the amount of money that is available to be paid over the expected life of the annuitant assuming a minimum rate of interest.  The payout rate is fixed, however, if an inflation rider was purchased, the income will be adjusted based on a fixed inflation index or a cost of living adjustment.

So, an immediate annuity is the right choice for someone who has an immediate need for income and who needs it to be predictable and secure. 

Fixed Annuity

A fixed annuity allows the owner to accumulate funds over time, crediting a fixed interest rate while shielding the accumulating interest from current taxes. A fixed annuity, also known as a deferred annuity, defers the generation of income to some point in the future, usually after retirement, when it is needed. Once that conversion, or annuitization, occurs, the accumulated funds are irrevocably committed to the income and cannot be accessed in the form of a withdrawal. 

A fixed annuity, therefore, is ideal for someone who doesn’t have an immediate need for income and has some time to accumulate more savings.

It would seem that we are describing solutions for two different scenarios based on entirely different needs. A younger person in his or her prime earning years has no need for an immediate annuity but they might want to save for a future, guaranteed income through a fixed annuity.  An older person ,who has retired, might have a greater need for an immediate annuity to provide supplemental income with no ability to contribute to savings, so he would have no use for a fixed annuity.  The appropriate solution appears obvious in both cases.

The question as to whether to buy a fixed annuity over an immediate annuity would most likely come into play for someone, at or near retirement ,with a need for additional income but may be in a position to  defer the need to some point in the future.  For a person in this situation, the decision would come down to specific circumstances.

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Case Scenario

Consider the following scenario. This person, a man, is 65 years old.  He has calculated that the income generated from his 401(k) plan and Social Security will cover his most basic needs accounting for inflation over the course of his life expectancy. In addition, he has amassed a sum of money in a savings account worth $93,000.  

His goal for retirement is to be able to maintain the quality lifestyle he enjoyed during his earning years.  He also has the skills, knowledge and energy to continue to earn an income on a part time basis that can provide the supplement he needs to meet his lifestyle goals. 

Realizing that he might not be able to continue to work at some point, he wants to prepare for that time by creating another source of income that will meet his needs for as long as he is alive. He would want the income to be stable, predictable and to last as long as he does.   He would rather not have to actively manage this income sources and would prefer to have it operate automatically.

This is a situation where the person might consider moving a portion of his savings into a fixed annuity with a highly rated life insurer that could become a guaranteed income source when he is needs the additional income.  He should leave about a third of it in his savings account for emergencies. The benefit to him would be that his money would be secure with a guarantee of principle and would accumulate free of taxes at competitive interest rates. 

Then, when he needs the additional income, he would simply convert the fixed annuity into an immediate annuity that will pay him for life.  The advantage of waiting to annuitize is that, at an older age, his payout will be higher.  Also, a larger portion of the monthly payment will be a return of his principle which will not be considered taxable income.

As opposed to just purchasing one fixed annuity, he might consider buying two. This would give him more flexibility in the event he didn’t require as much income for supplement. He could allow the other fixed annuity to accumulate and, the longer he is able to wait to annuitize, the higher is payout will be in from the second annuity.

While a fixed annuity and an immediate annuity have very distinct purposes, from a planning perspective, there may be used for both.  As to the whether you should buy a fixed annuity over an immediate – the situation is always the boss.

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