Annuities provide insurance against longevity risk. Image: Northeast Underwriters.
Many people have trouble understanding annuities, but at their core, certain types of annuities can help you address risks that most other financial products can't. In particular, there are several groups of people who can benefit from an immediate annuity -- one of the most basic and easy-to-understand types of annuities out there. Let's take a closer look at the immediate annuity and who is in the best position to benefit from the protection that these insurance products provide.
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What an immediate annuity doesAn immediate annuity is in some ways the exact opposite of a life-insurance policy. With the typical life insurance policy, you pay monthly premiums to the insurance company throughout your lifetime, and at your death, your heirs receive the death benefit from the policy. With an immediate annuity, on the other hand, you typically make an upfront payment when you buy the annuity, and then the insurance company pays you fixed amounts of monthly income throughout your lifetime, with payments typically ending at death.
In actuality, there are several ways you can build on the basic immediate annuity product. In addition to single-life annuities, you can also get joint and survivor immediate annuities, which pay monthly income as long as you or a second person -- typically a spouse -- survives. Even after your death, your spouse can continue to receive annuity payments. Other annuities are structured to pay a minimum number of monthly payments, and if you die before hitting the minimum, then the insurance company will pay your heirs any remaining payments.
3 groups of people who can benefit most from an immediate annuitySo, with these characteristics in mind, the big question is who can get the most out of an immediate annuity? There are a few different groups that generally get the biggest bang for their annuity buck.
First, an immediate annuity is attractive to anyone who doesn't have other sources of reliable monthly income. The decline in interest rates in recent years exposed just how vulnerable retirees are to falling levels of portfolio income, and while most retirees have Social Security, their benefits are usually insufficient to replace all of their income needs. An immediate annuity can bridge that income gap and allow you to come up with a budget without worrying too much about financial market conditions.
Second, those who have a family history of living a long time can potentially profit from an immediate annuity. Insurance companies use a similar actuarial process in pricing immediate annuities that they use for life insurance, and with an immediate annuity, the longer you live, the more profitable the annuity is for you. By contrast, if you have reason to believe you might live a shorter-than-average lifespan, then an immediate annuity isn't as favorable to you because you'll typically lose your initial premium payment immediately after your death.
Finally, those who want to ensure that their spouse or other loved one has the financial resources he or she needs can often benefit from setting up a joint and survivor immediate annuity. That way, monthly income continues automatically even after your death, avoiding any disruptive breaks that can occur in the probate process. Your spouse or heir can rely on that income to help bridge any gaps in making other assets available during the inheritance process.
An immediate annuity can be a smart way for retirees to find ways to replace the income they earned during their careers. Immediate annuities aren't perfect for everyone, but if you fall into these three groups, then it's worth taking a closer look to see if they might serve your financial needs well.
The article Who Should Consider an Immediate Annuity? originally appeared on Fool.com.
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