Should You Choose an Immediate Variable or Fixed Annuity?

When you buy an immediate annuity, you pay a lump sum to an insurance company and begin receiving monthly payments right away. An immediate life annuity is attractive to retirees because it guarantees them a lifetime income. But should they choose an immediate variable annuity (IVA) or an immediate fixed annuity (IFA)?

The IFA gives you a guaranteed but fixed payment – generally monthly for your lifetime. That’s because the underlying annuity investment relies on long term bond investments purchased by the insurance company. But in twenty years the purchasing power of that fixed monthly payment may be significantly less due to inflation.
 
The IVA also offers a lifetime (monthly) payments, but those payments will vary. That’s because the underlying annuity money is invested in the subaccounts that fluctuate with the underlying securities (e.g. stocks and bonds). The attraction of the IVA is based on the hope that over time, the investment markets will rise and help offset inflation by producing larger monthly payments. The danger is that the stock market can go into a slump and reduce those payments.    

With the IVA, you can change how your annuity is invested among subaccounts associated with it. You can also opt for a guaranteed minimum payment despite how far down the market goes and your subaccount investment earnings fall. But that kind of guarantee will add to the cost of the contract.

If you’re especially concerned about future inflation, perhaps you’ve got a better option than locking yourself into an IVA. Instead of investing all that ‘annuity’ money into an IFA, just invest a portion – perhaps half of it. Then invest the remaining half in a conservative mix of bonds and stocks that’ll potentially generate both growth and earnings.

Use only the earnings of this that you need. This gives you more control of your investment money with your own guaranteed minimum from your IFA. Years later you can always opt to invest the balance into an IFA too. Your increased age alone will produce a higher monthly return for yourself because the later in life you start your annuity payments, the larger the payments.  You can see how this works with the immediate annuity calculator.
Note: Annuities once annuitized cannot be surrendered for value.  Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty.  Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses.

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