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The function of an immediate annuity is to provide risk-free monthly income for the rest of an annuitant's life. The annuitant has no exposure to stock market risk or the risk of outliving his assets. If the annuitant lives to be 120 years old, the annuity will continue to make the monthly payments until the annuitant dies. Conversely, if an annuitant buys an immediate annuity and then dies after only two months, the insurance company keeps the entire lump sum paid to purchase the immediate annuity.
The insurance company prices immediate annuities and their benefits based on the same actuarial tables used to price life insurance policies. These tables outline the life expectancy of annuitants and insureds, and they are a closely guarded secret of the insurance companies. The insurance company issuing the annuity is betting, based on their tables, that an annuitant will die before the benefits they've paid the annuitant exceed the amount the annuitant paid for the immediate annuity.
The size of an immediate annuity is an important consideration when contemplating this retirement strategy. The more a person invests, the higher their monthly payments will
be. However, it's not a good idea to invest everything a person has into an immediate annuity because, once it is purchased, it is irrevocable and cannot be sold or borrowed against. The best strategy is to make a realistic assessment of ones income needs and then only invest an amount that will meet those needs.
One thing a retired couple needs to consider when contemplating an immediate annuity is how the surviving spouse will be provided for after the death of the annuitant. One option is to add the spouse to the policy. It will lower the monthly income a little, but then the immediate annuity will pay as long as both people live. A single person buying an immediate annuity may also designate an heir to be paid in the event of their death for a set period of time.
The greatest benefit of an immediate annuity is that it takes the guesswork out of retirement. If a retiree can afford an immediate annuity that meets all of his income needs, he never has to worry about outliving his money. Chances are, that peace of mind might actually help him to live longer.