An annuity is a promise by a life insurance company to provide you with a guaranteed monthly income for a given period of time (for example, the rest of your life or that of your spouse, depending on the conditions of the contract) in exchange for receiving a determined lump sum amount.
Several factors affect the actual payment you receive:
The monthly payment is based on interest rates at the time you contract the annuity, which can be an advantage or a disadvantage, depending on how interest rates change in the future. Remember that annuity rates are always changing because the price of a life annuity is very sensitive to long-term interest rates. A small change in interest rates can have a significant effect on the lifetime income provided.
Any additional options or features on an annuity will cost extra in the form of reduced monthly payments. For example, the higher the guaranteed period, the higher the cost-of-living adjustments (COLAs) and the greater the survivor benefits, the lower the monthly payment you will receive.
Advantages of an Annuity
Disadvantages of an Annuity
There are essentially two types of annuities: term certain and life. These will be discussed in the sections that follow.
Under a term certain, or ordinary annuity, the capital and the accrued interest are paid out over the contracted period of time. The amount in the annuity decreases to zero or a contracted final amount with the last payment. Age and life expectancy are not part of the payment calculations. For example, a term certain annuity could be set up to age 90, and payable until you reach 90 or your spouse turns 90.
An annuity is like a mortgage or loan in reverse. You are lending your money to a financial institution, which pays it back to you with interest over the contracted period of time. You contract the terms with them, including your agreement that you will not receive any additional portion of the capital earlier than the full term of the annuity or until it is used up.
If you set up a term certain annuity to provide income for the rest of your life, you may guess that you will live for a period of 30 years. If you then die after 25 years, your estate will continue to be paid for five years after your death. However, if you live for 35 years, you’ll be without income for the last five years of your life.
Under a life annuity, the periodic payments can continue for as long as you live. Some of the interest that would normally be paid to you under an ordinary annuity is used to fund the cost of insurance so that if you live longer than expected, the payments will continue until you die.
Assuris is the insurance industry’s insurance plan. It protects your benefits if a member company fails financially. Annuity income benefits are protected—up to $2,000 per month or 85% of the promised monthly income benefit, whichever is higher. If your monthly benefit is going to be more than $2,000, you should split your annuity between member companies. If the companies later merge, your benefits will continue to be covered.
A life annuity can include provisions for:
The annuity market can be quite competitive. You should get quotes from several insurance companies when you are ready to buy.
Payments on a stated lump sum amount of money will differ among life insurance companies, so remember to shop around for your annuity and compare payments and terms among several life insurance companies.
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