Income Annuities

Written By : Elaine Silvestrini
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An income annuity is an annuity contract that converts all or part of a consumer’s savings into a guaranteed stream of income, either for the consumer’s lifetime or for a specified number of years. These payments can begin right away, in the case of an immediate annuity, or at a later time when the product is a deferred annuity.

Income annuities are contracts with insurance companies that provide the contract holder with a stream of income in exchange for one or more premium payments. The income schedule can be monthly, quarterly or annual, as long as the payments are consistent.

Income annuities are different from growth annuities in that the money is paid out over time instead of withdrawn in a lump sum after a period of accumulation.

To illustrate this difference, consider Webster’s New World College Dictionary’s definition of the word “annuity.”

Annuity
  1. a payment of a fixed sum of money at regular intervals of time, esp. yearly
  2. an investment yielding periodic payments during the annuitant's lifetime, for a stated number of years, or in perpetuity

The origin of the word is “annuus,” the Latin word for “annual.” Hence, annuity contracts were originally intended to guarantee steady, regular income.

Varieties of Income Annuities

One of the most attractive qualities of most annuities is their ability to provide guaranteed income at a time when retirees are increasingly required to live off their savings, the future of Social Security is in question and traditional pensions are practically nonexistent.

Income annuities are classified according to when you begin receiving your stream of payments.

Immediate
If the consumer begins receiving the income within a year of purchasing the annuity, it’s known as an immediate income annuity, also called a single premium immediate annuity or SPIA. Typically, immediate annuities are purchased with a single lump sum payment.
Deferred
If the payout, or distribution, phase begins a year or more later, the income annuity falls into the category of deferred income annuity, or DIA. Deferred annuities purchased with a lump sum are called single premium deferred annuities, or SPDAs. Deferred annuities purchased with multiple payments are known as flexible premium deferred annuities, FPDAs.

The income payments from a deferred annuity are typically higher than payments from an immediate annuity for two reasons.

First, with a deferred annuity, your principal has time to accumulate before you start taking payments. The second reason is specific to life annuities, which pay income for the remainder of the annuitant’s life. In these cases, the longer the annuitant waits to receive payments, the fewer payments he or she will receive. Fewer payments mean larger payments.

Some annuities are treated more like certificates of deposit, with the annuitant allowing the money to grow over time and withdrawing the full amount at the end of the contract. These types of annuities are called multi-year guaranteed annuities, or MYGAs.

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Income Annuities Protect Against Risk

Income annuities also provide insurance against outliving your assets. So no matter how much your principal has grown and even if you have received all your principal and earnings as income payments, you will continue to receive income payments for the remainder of your life.

Mortality credits generated from lifetime income annuities are a unique benefit of these products. They essentially allow the insurance company to use the remainder of the premiums from annuitants who die earlier than expected to subsidize people who live longer.

If you die before you receive all your payments and you haven’t purchased a rider to allow for beneficiaries, then your remaining funds are used to pay people who live beyond their life expectancy.

According to a white paper by the Alliance for Lifetime Income, retirement financial strategies that rely only on investments and do not include annuities fail to fully account for all of the risks.

By providing guaranteed income, annuities protect retirees from common retirement risks, including longevity, market volatility, and inflation, as well as the uncertainty of Social Security and their own mismanagement of their finances.

To ensure you’re making the right move when you purchase an annuity, you must have a solid financial plan and a clear objective for the role of an annuity in that plan.

Growth Annuities

Some annuities are treated more like certificates of deposit, with the annuitant allowing the money to grow over time and withdrawing the full amount at the end of the contract.

For example, multi-year guaranteed annuities, or MYGAs, are fixed annuities that offer a guaranteed minimum rate of return for a set time period.

Growth annuities can be classified as fixed, indexed and variable.
  • Fixed annuities pay an interest rate that is set in the annuity contract and not dependent on other investments.
  • The growth rate of an indexed annuity is determined by the performance of an outside index, such as the S&P 500.
  • A variable annuity is riskier in that the insurance company invests its principal in a portfolio that contains a variety of investment vehicles, including stocks, bonds and mutual funds. The value of a variable annuity may grow or shrink, depending on its underlying investments.

Understanding Annuity Classification

An annuity will often fall into more than one classification.

For example, you could purchase a fixed deferred annuity, which would allow your principal to grow at a guaranteed minimum interest rate. Your income payments would begin some years later.

Definitions of Fixed and Deferred Annuities

Or you may opt for a single premium immediate variable annuity, or SPIVA. You would purchase this income annuity with a lump sum, and your income benefits, which would vary according to the performance of investments in your underlying portfolio, would begin within a year.

Definitions of Single Premium, Immediate, and Variable Annuities

9 Cited Research Articles

  1. Bell, A. (2019, April 12). Demand for Income Annuities Is Out There: Idea File. Retrieved from https://www.thinkadvisor.com/2019/04/12/demand-for-income-annuities-is-out-there-idea-file/
  2. Chen, James. (2019, May 7). Immediate Variable Annuity. Retrieved from https://www.investopedia.com/terms/i/immediate-variable-annuity.asp
  3. Kagan, J. (2018, December 18). Sequence Risk. Retrieved from https://www.investopedia.com/terms/s/sequence-risk.asp
  4. Klein, R. (2014, May 12). 8 reasons fixed-income annuities belong in your IRA. Retrieved from https://www.marketwatch.com/story/8-reasons-fixed-income-annuities-belong-in-your-ira-2014-05-12
  5. Langone, A. (2019, May 1). Income Annuities Are Gaining Popularity as a Way to Make Your Money Last in Retirement. Here Are all the Pros and Cons About This Controversial Product. Retrieved from http://money.com/money/5642645/what-are-income-annuities-money/
  6. National Association of Insurance Commissioners. (2007). Buyer’s Guide to Fixed Deferred Annuities. Retrieved from https://www.naic.org/documents/prod_serv_consumer_anb_lp.pdf
  7. Pfau, Wade. (n.d.). Protected Lifetime Income A New Formula and Category for Today’s Modern Retirement Plan. Retrieved from https://fb53c249d56cbdc517b3-a0041c3964186a9714763246bc825d85.ssl.cf1.rackcdn.com/Pfau-Pardo-Alliance-Risk-Pooling-Research-Paper21_181015_181207.pdf
  8. Pfau, W. (n.d.). Taking a Closer Look at Deferred Income Annuities. Retrieved from https://www.onefpa.org/journal/Pages/DEC14-Taking-a-Closer-Look-at-Deferred-Income-Annuities.aspx
  9. Webster's New World College Dictionary, Fifth Edition (n.d.). Annuity dictionary definition. https://www.yourdictionary.com/annuity
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