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how income annuities work

How Do Income Annuities Work?

Categories: Annuity Education, Annuity Strategies, Immediate Annuities

Nearing or at retirement age and want a strategy for retirement income? Income annuities might be the right answer for you. But how can you tell for sure?

In this article, we’re discussing what income annuities are and how they work. Income annuities let you convert portions of your retirement savings into guaranteed income streams. You can purchase an annuity with a lump-sum premium or through flexible payments over time.

In return for these premiums, you will receive payouts at agreed-upon intervals (monthly, quarterly, semi-annually, or annually).

If you’re wondering whether income annuities are the right decision for you, consider contacting the annuity professionals at AnnuityAdvantage. For over 25 years, we’ve guided our clients to the annuity product that best fits their retirement needs. Continue reading to learn more about income annuities and how they might be the best option for your retirement.

How Do Income Annuities Work?

Income annuities are designed to distribute a sum of cash (premium deposit) into regular income payments over time. These insurance contracts involve the annuitant paying a specified amount of money, and in exchange, having an insurer make regular income payments for a certain length of time or the rest of his/her life depending on the contract.

With income annuities, you will likely have the option to receive payments, monthly, quarterly, or yearly depending on your needs. Income annuities typically start payments within a year, which is why they are often called immediate annuities. However, they can also be categorized as deferred income annuities with payments beginning at a future date of your choosing, more than one year down the road.

Unlike other annuities, immediate income annuities are annuitized immediately, with payments typically beginning one month after contract issue. This is in opposition to accumulation or deferred annuities. People have the option to never annuitize or delay annuitization for long periods of time with deferred annuities.

As with other annuities, income annuities are complex financial products that require significant deliberation. If you’re considering purchasing an annuity, you should consult a professional and ensure you understand all of the fine print. You should ask about commissions and fees, state premium taxes if applicable, and understand the free-look period.

When Do Income Annuity Benefits Typically Begin?

One of the most attractive features of income annuities is their ability to provide guaranteed income during retirement. You can customize your annuity contract so income payments begin immediately or at a later date.

With immediate income annuities, payments begin within a year of the annuity’s purchase date. With deferred income annuities, income payments begin at least one year after the initial purchase. These types of annuities might be a preferable option if you don’t plan to retire for some time or you don’t need income right away.

What Are the Pros and Cons of Income Annuities?

As with any other financial decision, income annuities pose pros and cons you should consider before making a final decision. The most substantial benefit of income annuities with a lifetime payout is the assurance you won’t outlive your retirement savings. Because insurance companies guarantee your payments with the annuity contract, you will have guaranteed income for as long as the contract stipulates. Lifetime payouts are the most popular option selected.

Pros of Income Annuities?

Some other pros of income annuities include the following:

  • Customizable payment term and income start date.
  • Tax-favored income for non-qualified funds via an exclusion ratio.
  • Predictable and protected income guaranteed by a financially sound insurance company.

Cons of Income Annuities?

The most obvious example of a drawback to income annuities is that they often pay a fixed amount of income and inflation can eat away at your purchasing power over time. Insurance companies make inflation riders available which increase income payments annually so you can reduce or eliminate the negative consequences of inflation. However, these riders typically decrease the initial amount of income you will receive from a set deposit amount, so a complete analysis of the rider’s impact to your overall payment structure must be taken into consideration before deciding if it makes sense for your individual situation or not.

Some additional cons of income annuities:

  • Income annuities may not provide money for your heirs.
  • Once purchased, income annuity funds typically do not easily convert into cash.
  • Lack of flexibility. Once annuitized, you won’t be able to make any alterations to your payment schedule, even if your circumstances change in the future.

How Much Income Can You Expect to Earn from an Income Annuity?

Unlike certificates of deposit, lifetime income annuities do not provide a fixed return. Instead of a fixed rate, you receive an agreed-upon payment amount based on your life expectancy at the time payments begin. The total payout from your annuity depends on how long you live. The longer you live, the more total income you will receive.

If you structure payments to only last for your lifetime, you stand to receive larger incremental payments. If you are willing to accept lower monthly payments, you might be able to structure your annuity payout to provide for you, your spouse, or other beneficiaries after you die.

Ultimately, how much money you receive from an income annuity depends on your age at issue, the amount of premium deposit, how long you live and the payment options selected.

Longevity Risk Protection

A lifetime income annuity insures against the risk of living longer than average.

Risk-pooling and guarantees are what make lifetime annuities so valuable. With lifetime income annuities, the 50 percent of people who die earlier than average subsidize those who live longer. Since you don’t know which half you’ll be in, it makes sense to reduce your risk...especially if you are healthy and your family has a history of long lives.

Income Annuity FAQs

Who Guarantees Income?

The insurance company that issues the annuity guarantees your income. Because of this, you should make sure the company is financially sound with high ratings and that you understand the way they structure their annuities.

What Is the Rate of Return On an Income Annuity?

Income annuities do not operate like an investment that provides you with a rate of return over fixed periods of time. With income annuities, you’ll receive a set monthly income guaranteed for a specific period of time or life.

This guarantee is independent of market performance and the total payout is based on your life expectancy when selecting a lifetime payment stream. With income annuities that provide guaranteed income for life, the longer you live, the more total income you will receive.

How Soon Will Payouts Begin?

The date when your payouts begin depends on the agreement between you and the insurance company. Payouts might begin right away or they can be put off until a later period. With a single-premium immediate annuity (SPIA), you start receiving income within 12 months of your purchase.

With a deferred income annuity (DIA), your payments won’t begin until sometime between two to 40 years. However, as with a SPIA annuity, you will have the option to receive monthly, quarterly, semi-annual, or annual payments.

Bottom Line – How Does an Income Annuity Work?

Income annuities might be an excellent choice for you if you’re looking for guaranteed income throughout your retirement. However, there are some elements to consider when choosing your annuity.

That’s why we recommend that you consult an experienced annuity advisor who understands your financial needs and who can put you on the right path for your retirement. For over twenty-five years, we at AnnuityAdvantage have provided our clients with expert advice that positions them in a comfortable spot for their retirement goals.

Contact us today to learn more about how AnnuityAdvantage can help you with your retirement goals.