Income Annuity: What It Is and How It Works

Key takeaways

• An income annuity (also called an immediate annuity or single-premium immediate annuity — SPIA) converts a lump-sum premium into a stream of periodic payments that typically begin within a month.
• Payments can be fixed or variable, paid monthly, quarterly, semiannually, or annually, and can continue for a lifetime, for the lives of joint annuitants, or for a guaranteed period.
• Income annuities are commonly used as longevity insurance to ensure steady retirement income, but they are illiquid and may not protect fully against inflation unless riders or indexing are included.

What an income annuity is

An income annuity is an insurance contract bought with a lump sum that immediately begins paying regular income to the purchaser (the annuitant). It is designed to swap capital for predictable cash flow, often to cover living expenses in retirement. Deferred annuities, by contrast, begin payments at a later date.

How it works

• Purchase: You pay a single premium to an insurance company.
• Start of payments: Payments typically begin within a month of purchase (timing depends on contract terms).
• Payment structure:
• Life-only: pays until the annuitant dies.
• Joint-life: pays until the last surviving covered person dies.
• Period-certain: guarantees payments for a set number of years even if the annuitant dies early.
• Cash refund: if the annuitant dies before receiving payments equal to the premium, the beneficiary receives the remaining balance.
• Underlying investments: Payments may be based on fixed investments (fixed annuity), variable investments (variable annuity), or linked to indices (indexed options). Variable/indexed structures can cause payment fluctuations or offer higher potential returns.
• Return depends on longevity: The longer you live, the more payments you receive, effectively increasing the annuity’s return on your premium.

Common options and riders

• Inflation/indexing rider: increases payments over time to help preserve purchasing power (usually at an added cost).
• Period-certain or cash-refund features: protect beneficiaries or return unused premium.
• Joint-and-survivor options: continue payments to a spouse or partner.
• Deferred income annuities: purchased now but begin payments at a future date to build higher payouts.

Who benefits most

• Retirees worried about outliving savings — income annuities act as longevity insurance.
• People who want a predictable, guaranteed income stream to cover recurring expenses (housing, utilities, care costs).
• Those who don’t need immediate access to the principal and prioritize stable lifetime income over liquidity.

Advantages

• Predictable, reliable income for life (if chosen as life annuity).
• Can simplify retirement cash management by covering a baseline of essential expenses.
• Some contracts include death benefits that protect beneficiaries.

Disadvantages and risks

• Illiquidity: once purchased, the premium generally can’t be withdrawn.
• Inflation risk: fixed payments lose purchasing power unless indexed.
• Credit risk: payments depend on the insurer’s ability to meet obligations.
• Opportunity cost: locking up capital may forgo higher returns elsewhere.
• Fees and complexity: riders and variable features can add cost and complexity.

How to decide if it’s right for you

Consider:
* Your life expectancy and health (longer expected lifespan increases value).
* Existing guaranteed income (Social Security, pensions) and how the annuity would fit.
* Need for liquidity and emergency funds.
* Inflation exposure and whether you need indexed payouts.
* Financial strength and ratings of the issuing insurance company.
* Alternatives (bond ladders, TIPS, systematic withdrawals, longevity bonds).

Practical tips

• Compare quotes from multiple insurers and check financial strength ratings.
• Evaluate riders carefully — they add cost and may not be necessary if other inflation protection exists.
• Consider a partial annuitization strategy (annuitize a portion of retirement assets) to balance liquidity and lifetime income.
• Consult a financial planner or insurance specialist to match contract features to your retirement goals.

An income annuity can be an effective tool for converting savings into dependable retirement income, especially for those prioritizing lifelong payments over liquidity and market participation. Carefully weigh contract terms, insurer strength, and how the annuity complements other retirement income sources before buying.