Life insurance buys
financial protection against your premature death. Here’s the how-to on another
insurance that protects you from living too long: the annuity.
Annuities often
secure steady cash flow to you during your retirement years through growing
invested funds. The payout process is known as annuitization.
Over the years,
annuities got a bad rap as insurance products. Like life
insurance, annuities generally sell to the public via a sales force of licensed
agents. Annuities also get
a bad rap because of the pure insurance (longevity) feature they provide –
especially pure life annuities, simply a guaranteed income stream that lasts as
long as the annuity holder (called the annuitant) is alive.
The downside to
this annuity: Once the annuitization starts, the annuitant who dies forfeits
the money to the insurance company. These annuities pay the most because you
the annuitant assume more of the risk – you might make only a payment or two
before your death.
The Details are Important
Annuities come with
pros, cons, and a huge heap of details, including:
- Mortality credits, or the percentage difference
between the agreed-upon initial return on your money in a pooled-risk annuity
and the actual return on your annuitization once some members of the pool die.
- Tax-deferred annuities allow you to put off
paying taxes and don’t eliminate taxes. Your tax depends on when you start
withdrawing from an annuity.
- The more complicated the annuity, the more
expensive its fees. Cheapest is likely a single-premium annuity you buy at age
65 with your payouts beginning in your early 80s. Variable annuities, payouts
of which vary depending on the performance of a related securities portfolio,
cost more.
- Annuities lock your money for a set period,
typically about seven years. Early withdrawals come with surrender charges that
decrease with time. You also lose your money if the insurance company itself
fails – a slim chance but a consideration for you after the storied
near-collapse of American International Group, a huge insurer.
- Add-ons such as guaranteed living benefit
riders, under which for a fee you remain invested as you wish, assured of a
minimum benefit base that grows over time.
The Concept Makes Sense
The concept of
annuity as life insurance – not a bad concept – hinges on risk pooling, or many
sharing the risk in their given pool. The same concept exists in auto and home
insurance. Most of us go our entire lives without making a claim for our home
burning down, at the same time participating in a pool that insures those whose
homes do burn down.
Likewise with
annuity risk pools: Those who die early pay for those who live longer. Even
Social Security seems a form of annuity, in that an individual could pay into
the system for a lifetime, retire and then die after receiving only a few
payments.
Annuities are
insurance products. Ask yourself, “What am I insuring?”
Answer: your
longevity, specifically maintaining a flow of cash during it.
What Should You Do?
Do you need an
annuity right now? Depends on your age and your income needs in retirement.
Generally, the younger you are, the less you need an annuity as there are many
other tax-favored vehicles that can build wealth over time.
Consider additional
factors if you’re older. If you receive Social Security as well as a pension –
the latter yet another form of annuity – you already partially insure your
retirement against outliving your money. Annuities constitute another tool to
back up your retirement funding.
Talk to your
financial professional.
