Immediate Annuity

A retiree wanting immediate monthly income from a lump sum should consider:

1. A.An aggressive growth fundAn aggressive growth fund pays little or nothing currently, so generating monthly income would mean selling shares each month, including in down markets. The retiree wants a payment stream, not a liquidation schedule.
2. B.An immediate annuityCorrect - immediate income from a lump sum.
3. C.A zero-coupon bondA zero-coupon bond makes no payments at all until maturity, which is the opposite of monthly income. It is also taxed on accreted interest the holder never receives, worsening the cash flow problem.
4. D.A deferred variable annuity with surrender chargesThe word annuity makes this look responsive, and it is the classic unsuitable recommendation in this fact pattern. Deferred means income does not begin now, and the surrender charges penalize the retiree for reaching the money he needs immediately.

Why: An immediate annuity converts a lump sum into income beginning right away.

An immediate annuity begins income payments:

1. A.At age 59 and a halfAge 59 and a half is the threshold below which distributions generally attract an early withdrawal penalty, a real rule applied to the wrong question. It governs tax consequences, not when an immediate annuity starts paying, which is within one payment period of purchase.
2. B.Only after 10 yearsA multi-year wait describes a deferred contract, and it echoes the length of a surrender charge schedule. An immediate annuity is bought with a lump sum precisely so income can begin right away, typically with the first payment one period later.
3. C.Never - it only accumulatesA contract that only accumulates is a deferred annuity that has never been annuitized. The immediate contract skips accumulation entirely, converting the purchase payment into an income stream at once.
4. D.Within one payment period of purchaseCorrect - income starts almost right away.

Why: An immediate annuity starts payments within one payment period of purchase (e.g., within a month for monthly payments).

A single premium immediate annuity differs from a deferred annuity principally in that the immediate contract

1. A.starts its payout within one payment interval of purchase and therefore has no accumulation phase.Correct. Timing is the whole distinction, and starting at once leaves no interval in which value can accumulate.
2. B.credits a guaranteed rate of interest, which a deferred contract is never able to offer.Wrong. A deferred fixed annuity credits a guaranteed rate too, so this separates nothing.
3. C.accepts a series of premium payments, whereas a deferred contract accepts only a single premium.Wrong. It inverts the funding pattern, since the single premium belongs to the immediate contract by definition.
4. D.escapes ordinary income treatment on the interest portion contained in each payment received.Wrong. Each payment still splits into a taxable interest portion and a tax-free recovery of the investment.

Why: The defining difference between the two contracts is when the payout begins, not what the contract invests in or how it credits interest. An immediate annuity is purchased with one payment and starts distributing within a single payment interval, so it never has an accumulation phase in which value builds up untouched. A deferred annuity accumulates first and annuitizes later, if at all. Both can be issued in fixed or variable form, so the crediting method does nothing to distinguish them.

Henrietta Vasquez, 76, transfers $300,000 to a university. Under the agreement the university will pay her a fixed dollar amount every year for the remainder of her life, and whatever remains at her death belongs to the university. This arrangement is a:

1. A.Charitable remainder unitrust.Incorrect. A charitable remainder unitrust is a separate trust that pays a fixed PERCENTAGE of its annually revalued assets. Here the payment is a fixed dollar amount owed directly by the charity under a contract.
2. B.Charitable lead trust.Incorrect. A charitable lead trust reverses the cash flows: the charity receives the income stream for a term and the donor's family receives the remainder.
3. C.Commercial single premium immediate annuity.Incorrect. A commercial annuity is issued by an insurance company for full value and generates no charitable deduction. Here part of the transfer is a gift and the payments are owed by the university.
4. D.Charitable gift annuity - a part-gift, part-purchase contract that is a general obligation of the charity, producing a current charitable deduction for the gift portion plus lifetime payments.Correct. One contract with the charity, backed by the charity's general assets, combining a deductible gift element with a fixed lifetime income stream.

Why: This is a charitable gift annuity: a single contract, part gift and part purchase of an annuity, entered into directly with the charity. Because the payment obligation is a general obligation of the charity backed by all of its assets, the donor takes on the charity's credit rather than the investment results of a segregated fund. The donor receives a current charitable income tax deduction for the excess of the amount transferred over the actuarial value of the annuity, and each annuity payment is part tax-free return of principal and part taxable income during the donor's life expectancy.