Immediate annuities offer not only the security of lifelong income but also tax advantages. Each payment is partially untaxed as a return of principal, at least initially. In most cases, the tax-free treatment ends after you have received the amount of principal in the contract. However, if an immediate annuity is purchased through the conversion of a life insurance policy, you can receive partially tax-free income indefinitely.
There are some drawbacks to immediate annuities, but they may be overcome. You don’t have to take a fixed amount and lock yourself into a loss of purchasing power; many insurers offer immediate annuities with cost-of-living increases, to provide inflation protection. The initial payment will be relatively low, though.
Another alternative is to buy an immediate variable annuity, which can provide long-term growth, if the investment accounts do well. Some immediate variable annuities come with a floor for downside protection.
For example, a 65-year-old couple might get $650 per month, as long as either lives, from a $100,000 joint-and-survivor fixed immediate annuity. A variable immediate annuity might pay only $360 per month, upfront, yet have the potential to double in a five-year bull market. An 80 percent floor ($288 per month, in this example) would provide some bear market protection for investors willing to take such risks.