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Life annuities represent one of the most significant financial tools for retirement planning, offering a unique combination of income security and longevity protection. But how do they work? And can anyone have one? Let’s explore what life annuities are, their basic attributes, and their role in financial planning.
Life annuities (in a nutshell)
A life annuity is a financial contract between an individual (the annuitant) and an insurance company that transforms a lump sum of money into a guaranteed stream of income payments for the remainder of the annuitant’s life. Think of it as creating your own pension: you give the insurance company a sum of money, and in return, they promise to pay you regularly until you die.
How life annuities work
The basic mechanics of these types of annuities are as follows:
- Purchase phase: The annuitant pays a premium to the insurance company, either as a lump sum or through periodic payments over time.
- Accumulation phase: If it’s a deferred annuity, the money grows tax-deferred until the payout phase begins.
- Distribution phase: The insurance company begins making regular payments to the annuitant, which can be monthly, quarterly, or annually.
Key types of life annuities
Within this type of annuity there are a few sub-categories you should be aware of:
1. Immediate vs. deferred annuities
- Immediate annuities: Payments begin right after purchase.
- Deferred annuities: Payments start at a future date, allowing for potential growth.
2. Fixed vs. variable annuities
- Fixed annuities: Offer guaranteed payment amounts.
- Variable annuities: Payments vary based on investment performance.
- Indexed annuities: Payments tied to market index performance with downside protection.
Features and options
Some common riders and provisions for life annuities include:
- Period certain: Guarantees payments for a minimum period, even if the annuitant dies.
- Joint and survivor: Continues payments to a surviving spouse.
- Inflation protection: Increases payments to keep pace with inflation.
- Death benefits: Ensures beneficiaries receive remaining value.
- Cash withdrawal options: Allows access to funds in emergencies.
Advantages of life annuities
Life annuities come with certain benefits that make them attractive:
1. Guaranteed income
- Provides predictable income that cannot be outlived.
- Helps maintain standard of living in retirement.
- Reduces anxiety about market volatility.
2. Tax benefits
- Tax-deferred growth during accumulation phase.
- Potentially lower tax burden through systematic payments.
- Portion of payments may be tax-free return of principal.
3. Protection features
- Insurance against longevity risk.
- Optional protection against market downturns.
- Potential creditor protection in some jurisdictions.
Disadvantages and considerations
And now for a few reasons this type of annuity might not be the best option for your specific financial needs:
1. Limited flexibility
- Usually irrevocable once annuitized.
- Reduced access to principal.
- May not leave substantial legacy for heirs.
2. Cost factors
- Insurance company fees and commissions.
- Rider costs can be significant.
- Potential surrender charges.
3. Opportunity cost
- May miss out on higher market returns.
- Limited inflation protection unless specifically added.
- Locked into current interest rates.
Who should consider a life annuity?
Life annuities are particularly suitable for individuals who:
- Want guaranteed retirement income.
- Have limited pension benefits.
- Are risk-averse.
- Seek to complement Social Security income.
- Want to ensure basic expenses are covered in retirement.
Making an informed decision
Given your unique financial situation, assess your current and projected retirement income needs, as well as other sources of retirement income. Your overall financial portfolio composition should be a major deciding factor.
Additionally, when it comes to selecting an insurance company, be sure to check out their financial strength ratings, as well as their reputation and history. Pay special attention to their claims-paying ability.
Lastly, does the annuity contain the kinds of product features you’re looking for? Payment options and flexibility are key, along with rider availability and costs. Are the surrender periods and charges to your liking?
Final thoughts
Life annuities serve as valuable tools in retirement planning, offering unique benefits that other financial products cannot match. While they’re not suitable for everyone, they can play a crucial role in creating a secure retirement income stream. The key is understanding their features, benefits, and limitations to make an informed decision that aligns with your financial goals and circumstances.
Pave the way with Stone Street
Do you need upfront money for any of the following?
- Annuity
- Structured Settlement
- Inherited Annuity
- Assignable Annuity
If so, we will work with you one-on-one so you get the options that best fit your needs:
- One-on-one consultation.
- Customized solution just for you.
- Customer service you can count on.
Call us at 866-416-5118 to talk about your financial needs and what annuity payments you have coming to you. We’ll do the hard work and handle the rest of the process!
