What is an immediate annuity?

An immediate annuity is an annuity that is “priced immediately” by the insurance company issuing the annuity to an individual seeking safety, tax benefits and income.


When may the payments start?

Annuity payments may start at any time from immediately after the annuity purchase date to 30-years after the annuity purchase date.


Are there tax advantages to starting annuity payments within one year?

Yes, for annuity cash purchases, the IRS will waive the normal 10% penalty for age pre-59 ½ payments normally accessed against annuity taxable income.   For an exchange purchase, and to avoid this penalty, initial payments should start after age 59 ½, or the payments should be made over your lifetime. For non-qualified annuity, the annuity purchase cost (cost basis) is slowly recovered/returned to contract Owner over the duration of the annuity or the Owner’s life expectancy depending on the annuity.


Are there tax advantages to starting payments that pay over your lifetime?

Yes, all taxable annuity income, regardless of age, is exempt from the 10% age pre-59 ½ penalty. If non-qualified annuity, the annuity purchase cost (cost basis) is slowly recovered/returned to contract Owner over the duration of the annuity or the Owner’s life expectancy depending on the annuity. This creates an internal deferral of income for annuity income that has yet to be paid.


How is annuity income taxed?

All annuity taxable income is taxed as “ordinary income” at your tax rate upon your receipt of the income.


Can I use my IRA funds to purchase an immediate annuity?

Yes, you can use Traditional IRA or ROTH funds to purchase an immediate annuity.


Can I include my spouse and children or siblings when I use traditional IRA funds?

Yes, you can incorporate your spouse, children or siblings when you use IRA funds to purchase an immediate annuity. These individuals can be jointly covered for annuity payments or just listed as beneficiaries, as long as you follow the pertinent IRA RMD rules there will be no RMD compliance problem.


May I exchange my existing deferred annuity or life insurance policy for an immediate annuity?

Yes, under the IRS 1035 exchange rules, the IRS permits a non-taxable exchange of a deferred annuity or life insurance policy for an immediate annuity. Make sure you check with the current insurance company to see what they may offer you based on their contract or policy guaranteed annuity payments.


If I do an exchange, how am I taxed on the annuity income?

There is no taxable event upon the 1035 exchange. You will be taxed on taxable annuity income as payments are received. For non-qualified contracts, the cost basis, the amount you paid for the original annuity contract or life insurance policy is also transferred to the immediate annuity. This will help to determine how much annual income is actually going to be taxable.


After such a 1035 exchange, what if the cost basis is greater than the cash transferred to the new annuity?

You will reap a tax benefit (non-taxable income) to the extent that the cost basis exceeds the annual annuity income when matched against the annual cost basis amount received.


What is a good time to purchase an immediate annuity or deferred income annuity?

Any time that you have capacity and available resources to make an immediate or deferred income annuity purchase is a good time. You get the safety of the contract and if the contract is paid over your current assumed life expectancy say 20 years, the insurance company cannot assume a greater life expectancy say 22 years in the future if their estimate changes. Carriers are constantly assuming longer life expectancies and the longer the duration the lower the payment. Interest rates also effect annuity payments but are just one factor of many factors.


Do I incur an expense or fee to purchase an immediate annuity?

No, out of pocket cost expense or fee is charged to purchase an immediate annuity. However, if your contract has a payment commutation or withdrawal feature, there may be a cost incurred when the feature is exercised. The insurance company will pay the agent a commission to sell the annuity. Estimated agent commission rates range from 1.50% – 4.00% depending on the insurance company and the particular contract’s terms and conditions and the agent’s agreement with the insurance company.


If I purchase an immediate annuity then, later transfer my contract ownership to my spouse, children, siblings or a trust, am I taxed upon the ownership transfer?

Generally no, immediate annuities are “fully matured” contracts. The new owner will start to incur income taxes, paid at their income tax rates, on the annuity income as received.


If I die owning a deferred annuity or life insurance policy with annuity or “settlement” rights do these rights transfer to my beneficiaries?

Yes, your beneficiaries inherit the same annuity rights and guarantees you had along with the contract/policy cost basis unless contract/policy language states otherwise.


If I die owning an immediate annuity will my beneficiaries receive any benefit?

It depends on the immediate annuity. If the immediate annuity incorporated a joint and survivor feature or a period certain feature and death occurred during the period certain duration then, yes other annuitants and or beneficiaries will receive some benefit.


I see immediate annuity ads all the time featuring 10% – 12% interest rates, is this true?

These ads are slightly misleading. Interest rates are very low and have been for a number of years. Because immediate annuities are guaranteed and under the current interest rate environment, the interest rates they incorporate are in the 1.00% – 3.50% range depending on the immediate annuity terms and conditions. The difference between these interest rates and the rates usually cited in such ads are the “mortality cost sharing credits”. Because there is a high chance of death at older ages, when such annuity contracts terminate without further value, the mortality cost sharing credits produce much higher payments. But this has nothing to do with interest rates. This is merely the insurance company’s estimated on how quickly you might die after purchasing the contract.


How does mortality cost sharing work?

A simple example is; you have six individuals who each contribute $1,000 to an envelope then, at the end of the year, the survivors meet to divide the contents of the envelope. If there are five survivors each receives $1,200 ($6,000/5 individuals). The survivors received an extra $200. In this case there was no interest earned because envelopes don’t pay interest. The survivors received an extra 20% ($200) merely because they survived. This is mortality cost sharing.


Given the above, how does mortality cost sharing work with immediate annuity contracts and insurance companies?

Because we are talking about insurance companies the dynamic is slightly different than with envelopes. The carrier makes an initial estimate at the beginning of the year that one may die before the end of the year. In this case, all six initial individuals receive the same promise of the end of year $1,200 payoff.   As long as one dies it’s no problem, however, if none die then the insurance company has to use its reserves to make-up the extra $1,200 payment not anticipate at the beginning of the year at the end of the year so that all six survivors receive the same $1,200 guarantee. In addition, there would be some interest earnings say $200 at the end of the year likewise shared.


I want to look into buying a reversionary annuity but can’t find an agent who knows anything about this, what do I do?

Please contact the author here.


How is reversionary annuity income taxed to the beneficiary?

The income is taxed as “ordinary” income at the beneficiary’s income tax rate. The carrier calculates the annual taxable income after determining the annuity “cost basis”, the non-taxable income portion and paid over the beneficiary’s life expectancy. In this manner some of the annuity income is taxable and some is not taxable.


Why do reversionary annuities produce so much more survivorship income than life insurance?

Different than life insurance, reversionary annuities take into account both lifetime expectations of the insured for the death and the beneficiary for the income. Also unlike some life insurance, reversionary annuities don’t have cash values that can be retrieved at a later date from the policy so a reversionary annuity stays in force over its duration.   Instead, the reversionary annuity beneficiary vests (up to 100%) over time in the survivorship income payment as the owner pays the policy premium.

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