Income Annuity Guide
An income annuity is an immediate annuity that provides a specified amount of income. It is a contract between the annuitant and an insurance company that is most often purchased with one lump sum, as opposed to monthly or annual contributions made over time.While most people consider an annuity to be more of an investment product than an insurance product, it should be viewed as a way to insure assets and income. An income annuity insures that the annuitant will receive income over a period of time. The length of time can be a specified amount of time such as 10, 20 or more years, or it can be for the life of the annuitant. Income annuities can also be purchased with a “period certain” option that will provide income to a spouse or beneficiary following the death of the original annuitant.
Income Annuity Risk
When an investor purchases an income annuity, he or she is actually transferring the risk of outliving available assets to the insurance company. In other words, because an annuity provides guaranteed payments, the amount and length of those payments are based on the risk the investor has of outliving his or her assets. Like other insurance products, annuities can be thought of in terms of risk transfer. For example, when a driver purchases car insurance, he or she transfers the financial risk of an accident to the insurance company in exchange for paying monthly premiums. With an annuity, the insurance company guarantees payments in exchange for a single premium.
Generating Lifetime Income
Financial planners will often discuss “longevity risk” with their clients. The term refers to the risk an investor has of outliving his or her money. According the Internal Revenue Service, an average 70-year-old man today can expect to live to the age of 87. That is 11 years longer than the average life expectancy of 78. That’s because life expectancy is based on the average age at which a person born today will die. In other words, the older one gets, the more likely it is that he or she will live past the average life expectancy. For a large number of people, retirement savings must last 20 to 30 years, not 10 to 15.
Income can also be guaranteed for a surviving spouse. Another option with an income annuity is a death benefit that is paid to the spouse or other beneficiary if the original annuitant passes away before the full amount of the premium has been returned. If the owner bought a $300,000 income annuity and received monthly payouts totaling only $100,00 at the time of his or her death, the spouse or beneficiary would be paid $200,000. This type of option guarantees that the estate does not lose the remaining value of the account.
Life Expectancy and an Income Annuity
Life insurance companies employ actuaries to determine the estimated life expectancy of the annuitant. The actuarial department will review personal information such as medical history, education level and lifestyle choices to estimate over how many years payments will be made. These factors are then combined with the purchase amount of the annuity and the length of the contract to determine the amount of money that will be paid each month or each year. Of course the annuitant will hope to live longer than expected in order to continue collecting payments. The insurance company, however, is assuming that the purchaser will not live longer than expected.
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An Immediate Income Annuity
Income annuities are immediate. They are designed to payout a guaranteed amount of income each month once the annuitant “annuitizes” the contract. An investor in need of immediate monthly income will possibly realize that over a number of years, an income annuity can provide superior financial security than other types of investments.
Income annuities typically do not expose the investor to the extreme gyrations of the stock and bond markets. And, to protect against a loss of purchasing power due to inflationary pressures, a Cost of Living Adjustment rider can be added to the contract. It is important to note, however, that a COLA rider will may reduce the amount of the payments during the initial years of the contract.
An income annuity if sometimes referred to as a “personal pension”. For investors who will not be receiving a pension from a previous employer, the funding of an income annuity with a single premium can be a great way to ensure lifetime income. The return on an income annuity can be either a fixed amount, or it can be variable. A variable annuity can provide higher rate of return than other risk-averse investments such as Certificates of Deposit. However, unlike CDs, annuities are not FDIC insured.
Comparing Annuities to Stocks, Bonds and Certificates of Deposit
For investors who need to ensure that they will have guaranteed income, an income annuity will more than likely provide security and stability that other investment vehicles cannot. Unlike stocks and bonds, which can expose investors to significant risk of loss of capital, income from an annuity is guaranteed.
It’s also possible that an income annuity will pay a higher interest rate than a Certificate of Deposit. While CDs have a place in every retired investor’s portfolio because they are liquid assets, they are subject to extreme reductions in the rate of interest paid. It is, however, important for all investors to realize that unlike bank-issued CDs, the money in an annuity is not insured by the Federal Insurance Deposit Corporation (FDIC).
For many investors, an income annuity can be a safe and sound method of guaranteeing monthly income for life. Even in a stressful economic environment, investors can look forward to knowing that their payouts will be received without interruption.
For even greater peace of mind, income annuity investors are always advised to ensure that the insurance company from which they purchase the annuity is rated at least A+ or better by one of the financial ratings firms, A.M. Best, Moody’s Investor Services or Standard and Poor’s.
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