When in the market for any investment it is very important to remember how taxes will affect you. Just in recap lets discuss immediate annuities and how they work. Immediate annuities use a lump sum payment and annuitize it to create a lifetime income stream. In 2018 almost 10 billion dollars were annuitized through immediate annuities, and the industry is still growing. These annuities are primarily used to provide income when social security, pensions, and investments fall short. They have a lifetime guarantee backed by the issuing insurance company; therefore, the health rating of the insurance company you choose is very important.
How do Immediate annuity taxes work?
If you purchase an immediate annuity that has a cash value (variable deferred or Fixed Indexed) then the value of that annuity would be subject to required minimum distribution taxes. However, since all other immediate annuities require you to give up the cash value in exchange for the payments, they are exempt from RMD taxes. It also helps that the payment you receive from your annuity is generally level for your lifetime. With other investments the value of your investments is expected to grow subsequently increasing your RMD amount; however, with an immediate annuity, you get the same payment for life making it meaningless for the IRS to tax an invisible cash value. One caution that many immediate annuity buyers overlook is that the RMD amount is still due for the calendar year that you purchase the annuity. For example, an immediate annuity purchased in 2019 would still be responsible for an RMD, but that would be the last year that money would be part of the total IRA balance.
Retirees with large IRA balances that will suffer large RMDs throughout retirement could likely consider adding this to their portfolio. If pensions, social security, or other income does not cover their basic expenses they could benefit from a lifetime income stream. In addition, their IRA balance would be reduced saving them thousands in RMDs in the future. You get to cover the expense gap while letting your investments experience a lighter RMD blow.