Immediate Annuity
An immediate annuity is an insurance contract purchased with a single premium that begins making income payments to the annuitant within one payment period — typically within 30 days to one year — of the contract's issue date.
Immediate annuities, also called single premium immediate annuities (SPIAs), are the simplest form of annuity and most directly address the challenge of converting a lump sum of savings into a predictable income stream. A retiree who has accumulated assets in a 401(k), IRA, or taxable account can exchange a portion of those assets for a SPIA and receive guaranteed monthly, quarterly, or annual payments for life or for a fixed period.
The pricing of an immediate annuity reflects two main factors: interest rates and mortality assumptions. When the insurer prices a life annuity, it pools the longevity risk of all its annuitants. Participants who die early effectively subsidize payments to those who live longer than average — this mortality credit is what allows a life annuity to provide more income per dollar of premium than a simple bond portfolio. When interest rates are higher, annuity payments for a given premium are larger because the insurer can earn more on the reserve assets backing the contract.
Immediate annuities are available in numerous payout structures. A straight life (or life-only) annuity pays the highest monthly amount but ceases at the annuitant's death — there is no residual value for heirs. A joint and survivor annuity pays income for as long as either of two annuitants (typically spouses) is alive, with the payment often reduced to 50%, 67%, or 75% of the original amount after the first death. A life with period certain annuity guarantees payments for at least a stated period (e.g., 10 or 20 years) even if the annuitant dies early — the remaining guaranteed payments go to a beneficiary.
For non-qualified SPIAs, the IRS applies the exclusion ratio to determine what portion of each payment is a tax-free return of principal versus taxable income. The ratio is calculated by dividing the investment in the contract (the after-tax premium) by the expected return (the total anticipated payments based on IRS life expectancy tables). Once the full investment has been recovered, all subsequent payments are fully taxable. For qualified SPIAs purchased from IRA or 401(k) funds, the entire payment is taxable as ordinary income.
Immediate annuities are irrevocable in most cases — once the premium is paid and the income begins, the owner cannot access the lump sum again. This illiquidity is a fundamental trade-off that must be carefully considered before purchase. Some insurers offer commutation provisions that allow the commuted value of certain payout structures to be taken as a lump sum under specified circumstances, but these are contract-specific.