What is an ‘Annuity’
An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income stream for retirees. Annuities are created and sold by financial institutions, which accept and invest funds from individuals and then, upon annuitization, issue a stream of payments at a later point in time. The period of time when an annuity is being funded and before payouts begin is referred to as the accumulation phase. Once payments commence, the contract is in the annuitization phase.
Breaking Down ‘Annuity’
Annuities were designed to be a reliable means of securing a steady cash flow for an individual during their retirement years and to alleviate fears of longevity risk, or outliving one’s assets.
Annuities can also be created to turn a substantial lump sum into a steady cash flow, such as for winners of large cash settlements from a lawsuit or from winning the lottery.
Defined benefit pensions and Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass.
Annuities can be structured according to a wide array of details and factors, such as the duration of time that payments from the annuity can be guaranteed to continue. Annuities can be created so that, upon annuitization, payments will continue so long as either the annuitant or their spouse (if survivorship benefit is elected) is alive. Alternatively, annuities can be structured to pay out funds for a fixed amount of time, such as 20 years, regardless of how long the annuitant lives. Furthermore, annuities can begin immediately upon deposit of a lump sum, or they can be structured as deferred benefits.
Annuities can be structured generally as either fixed or variable. Fixed annuities provide regular periodic payments to the annuitant. Variable annuities allow the owner to receive greater future cash flows if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for a less stable cash flow than a fixed annuity, but allows the annuitant to reap the benefits of strong returns from their fund’s investments.
One criticism of annuities is that they are illiquid. Deposits into annuity contracts are typically locked up for a period of time, known as the surrender period, where the annuitant would incur a penalty if all or part of that money were touched. These surrender periods can last anywhere from two to more than 10 years, depending on the particular product. Surrender fees can start out at 10% or more and the penalty typically declines annually over the surrender period.
While variable annuities carry some market risk and the potential to lose principal, riders and features can be added to annuity contracts (usually for some extra cost) which allow them to function as hybrid fixed-variable annuities. Contract owners can benefit from upside portfolio potential while enjoying the protection of a guaranteed lifetime minimum withdrawal benefit if the portfolio drops in value. Other riders may be purchased to add a death benefit to the contract or accelerate payouts if the annuity holder is diagnosed with a terminal illness. Cost of living riders are common to adjust the annual base cash flows for inflation based on changes in the CPI.
Annuities: Who Sells Them
Life insurance companies and investment companies are the two sorts of financial institutions offering annuity products. For life insurance companies, annuities are a natural hedge for their insurance products. Life insurance is bought to deal with mortality risk – that is, the risk of dying prematurely. Policyholders pay an annual premium to the insurance company who will pay out a lump sum upon their death. If policyholders die prematurely, the insurer will pay out the death benefit at a net loss to the company. Actuarial science and claims experience allows these insurance companies to price their policies so that on average insurance purchasers will live long enough so that the insurer earns a profit. Annuities, on the other hand, deal with longevity risk, or the risk of outliving ones assets. The risk to the issuer of the annuity is that annuity holders will live outlive their initial investment. Annuity issuers may hedge longevity risk by selling annuities to customers with a higher risk of premature death.
In many cases, the cash value inside of permanent life insurance policies can be exchanged via a 1035 exchange for an annuity product without any tax implications.
Agents or brokers selling annuities need to hold a state-issued life insurance license, and also a securities license in the case of variable annuities. These agents or brokers typically earn a commission based on the notional value of the annuity contract.
Annuity products are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
Annuities: Who Buys Them
Annuities are appropriate financial products for individuals seeking stable, guaranteed retirement income. Because the lump sum put into the annuity is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs. Annuity holders cannot outlive their income stream, which hedges longevity risk. So long as the purchaser understands that he or she is trading a liquid lump sum for a guaranteed series of cash flows, the product is appropriate. Some purchasers hope to cash out an annuity in the future at a profit, however this is not the intended use of the product.
Immediate annuities are often purchased by people of any age who have received a large lump sum of money and who prefer to exchange it for cash flows in to the future. The lottery winner’s curse is the fact that many lottery winners who take the lump sum windfall often spend all of that money in a relatively short period of time.
With the retirement playing field littered with crushed investments and dreams, the safety of guaranteed income streams looks more attractive each day. Some annuities can provide such a guarantee.
If you ask an insurance company to define annuities, the marketing phrase the insurer will probably use is: «Annuities can produce an income stream you can’t outlive.» That can be true. Annuity payments can last for as long as you live – or even longer – because the payments are based on your life expectancy.
On the surface this sounds great, but annuities are among the most commonly misunderstood and misused financial products. «If you say the word ‘annuity,’ what do you mean? There’s so many different types,» says Stan Haithcock, also known as Stan The Annuity Man. «Saying you hate annuities is like saying you hate all restaurants.»
The trouble is annuities are often sold and not bought. Consumers are pushed into ill-fitting products because that’s what the broker is selling that month. It’s important to be an educated consumer when you shop for an annuity, so let’s look at what annuities are, how they work, and whether they make sense for you.
1. What is an annuity? An annuity is a contract between you and an insurance company to cover specific goals, such as principal protection, lifetime income, legacy planning or long-term care costs.
Even though they may be marketed as investments, «annuities are not investments,» Haithcock. «They’re contracts.» They lock you and the insurance company into contractual obligations, and breaking them – if that’s even possible – can come at a steep cost.
«Annuities have been around for centuries,» says Troy Bender, president and chief executive officer at Asset Retention Insurance Services in Laguna Hills, California. «In Ancient Rome, people would make a single payment in return for annual lifetime payments. Even back then, retirement planning was a concern.»
Annuities became popular in the U.S. during the Great Depression, when people began to worry about stock market volatility endangering their retirement, he says. Today, with pension plans becoming less common, «many retirees are looking toward annuities as an option to replace income streams.»
You buy an annuity because it does what no other investment can do: «provide guaranteed income for the rest of your life no matter how long you live,» says Walter Updegrave, editor of RealDealRetirement.com, a site offering retirement planning advice.
Beyond these basics, there’s little about annuities that’s simple. Annuities and the rules under which they operate can be complicated, so it might help to recognize that a common source of retirement income – Social Security – is an annuity of sorts.
«Annuities work by giving you limited access to your funds annually much like how income is received from Social Security,» Bender says.
2. How does an annuity work? An annuity works by transferring risk from the owner, called the annuitant, to the insurance company. Like other types of insurance, you pay the annuity company premiums to bear this risk. Premiums can be a single lump sum or a series of payments, depending on the type of annuity. The premium-paying period is known as the accumulation phase.
Unlike other types of insurance, you don’t pay annuity premiums indefinitely. Eventually, you stop paying the annuity and the annuity starts paying you. When this happens, your contract is said to enter the payout phase.
There’s great flexibility in how annuity payments are handled. Annuities can be structured to trigger payments for a fixed number of years to you or your heirs, for your lifetime, until you and your spouse have passed away, or a combination of both lifetime income with a guaranteed «period certain» payout. A «life with period certain annuity» pays you income for life, but if you die during a specified time frame (the period certain years), the annuity will pay your beneficiary the remainder of your payments for the contractual period you chose at the time of application.
As with Social Security, annuity lifetime income streams are based on the recipient’s life expectancy, with smaller payments received over longer periods. So the younger you are when you start receiving income, the longer your life expectancy is, or the longer the period certain term is, the smaller your payments will be.
Payments can be monthly, quarterly, annual, or even a lump sum. They can start immediately or they can be postponed for years, even decades.
«Annuities are highly customizable,» Haithcock says. Finding an annuity to meet your needs comes down to two questions, he says: First, «what do you want the money to contractually do? And second, when do you want those contractual guarantees to start?»
3. An immediate annuity begins paying income (almost) immediately. Although it’s annuitized immediately, an immediate annuity doesn’t start paying income right away. You make a single lump sum payment to the insurance company, and it begins paying you income one annuity period after purchase, which can be 30 days to one year later.
The period is based on how often you elect to receive income payments. For instance, if you choose monthly payments, your first immediate annuity payment will come one month after you buy it. Because payments begin so soon, immediate annuities are popular among retirees.
4. Deferred annuities provide tax-advantaged saving and lifetime income. With a deferred annuity, you begin receiving payments years or decades in the future. In the meantime, your premiums grow tax-deferred inside the annuity. They’re often used to supplement individual retirement accounts and employer-sponsored retirement plan contributions because most annuities have no IRS contribution limits.
«The only limiting factor would be the amount of premium an insurance company is willing to accept for the same individual,» says Ken Nuss, founder and chief executive officer of AnnuityAdvantage, an online annuity marketplace. This amount ranges from $500,000 to $3 million but is typically capped at $1 million to $2 million, he says.
«But if someone wanted to put more than that in, he could split it up among multiple insurance companies,» Nuss says.
An exception to annuity contribution limits are qualified longevity contracts (QLACs). These are deferred income annuities designed to help retirees turn retirement assets into a stream of lifetime income.
Under IRS rules, you can only convert up to $130,000 or 25 percent of your funding retirement account (whichever is less) to a QLAC in 2018.
Money in a QLAC is exempt from required minimum distributions (RMD) until age 85. This makes them useful for individuals approaching RMD age (70½) who don’t need all their distribution now and would like a lifetime income stream.
A deferred income annuity (DIA) can also provide a future stream of income but doesn’t have any IRS restrictions. These annuities can be held in retirement and non-retirement accounts and work like an immediate annuity except payments begin 13 months to 40 years in the future.
«They pay their holders income for life, however, only after that individual has reached a certain age,» Nuss says.
Not everyone is a good candidate for DIAs, he says. Those who may find them advantageous include individuals with the following:
- a family history of longevity and who want guaranteed income for their life or for a spouse’s life
- the ability to cover immediate income needs as well as emergencies, and
- the need to supplement retirement income in later years, such as to cover long-term care
Annuities generally fall into two categories: deferred and income. Each works differently and offers unique advantages.
Tax-deferred annuities: for retirement savings
Deferred annuities can be a good way to boost your retirement savings once you’ve made the maximum allowable contributions to your 401(k) or IRA.1 Like any tax-deferred investment, earnings compound over time, providing growth opportunities that taxable accounts lack.
Deferred annuities have no IRS contribution limits,2 so you can invest as much as you want for retirement. You can also use your savings to create a guaranteed3 stream of income for retirement. Depending on how annuities are funded, they may not have minimum required distributions (MRDs).
Bear in mind that withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty. Annuities also come with annual charges not found in mutual funds, which will affect your returns.
Deferred variable annuities have funds that may have the potential for investment growth. However, this can involve some market risk and could result in losses if the value of the underlying investments falls. Variable annuities are usually appropriate for those with longer time horizons or those who are better able to handle market fluctuations. Some variable annuities allow you to protect your investment against loss, while still participating in potential market growth.
Deferred fixed annuities offer a guaranteed rate of return for a number of years. Fixed deferred annuities may be more suitable for conservative investors or for those interested in protecting assets from market volatility. In this way, they’re similar to certificates of deposit (CDs).
However, deferred fixed annuities differ from CDs in that:
- Annuities are not FDIC-insured.
- Withdrawals from annuities prior to age 59½ may be subject to a 10% IRS penalty.
- Deferred fixed annuities may offer more access to assets than a CD.
- Annuity earnings compound on a tax-deferred basis.
Income annuities: for income in retirement
Income annuities may be appropriate for investors in or near retirement because they offer guaranteed3 income for life or a set period of time. They may allow you to be more aggressive with other investments in your portfolio, since they provide a lifetime income stream.
Keep in mind that you may have limited or no access to the assets used to purchase income annuities.
Immediate fixed income annuities offer a guaranteed, predictable payment for life, or for a certain period of time. Your guaranteed income payment cannot be affected by market volatility, helping shield your retirement income from market risk.
A cost-of-living increase is available at an additional cost to help your buying power keep pace with inflation.
Deferred income annuities4 are fixed income annuities that have a deferral period before income payments start. Because of the deferral period, you may get a higher income payment amount than you would from a comparable immediate fixed income annuity with the same initial investment. The cost-of-living increase is also available at an additional cost for deferred income annuities.
Why Do People Buy Annuities?
People typically buy annuities to help manage their income in retirement. Annuities provide three things:
- Periodic payments for a specific amount of time. This may be for the rest of your life, or the life of your spouse or another person.
- Death benefits. If you die before you start receiving payments, the person you name as your beneficiary receives a specific payment.
- Tax-deferred growth. You pay no taxes on the income and investment gains from your annuity until you withdraw the money.
What Kinds Of Annuities Are There?
There are three basic types of annuities, fixed, variable and indexed. Here is how they work:
- Fixed annuity. The insurance company promises you a minimum rate of interest and a fixed amount of periodic payments. Fixed annuities are regulated by state insurance commissioners. Please check with your state insurance commission about the risks and benefits of fixed annuities and to confirm that your insurance broker is registered to sell insurance in your state.
- Variable annuity. The insurance company allows you to direct your annuity payments to different investment options, usually mutual funds. Your payout will vary depending on how much you put in, the rate of return on your investments, and expenses. The SEC regulates variable annuities.
- Indexed annuity. This annuity combines features of securities and insurance products. The insurance company credits you with a return that is based on a stock market index, such as the Standard & Poor’s 500 Index. Indexed annuities are regulated by state insurance commissioners.
What Are The Benefits And Risks Of Variable Annuities?
Some people look to annuities to “insure” their retirement and to receive periodic payments once they no longer receive a salary. There are two phases to annuities, the accumulation phase and the payout phase.
- During the accumulation phase, you make payments that may be split among various investment options. In addition, variable annuities often allow you to put some of your money in an account that pays a fixed rate of interest.
- During the payout phase, you get your payments back, along with any investment income and gains. You may take the payout in one lump-sum payment, or you may choose to receive a regular stream of payments, generally monthly.
All investments carry a level of risk. Make sure you consider the financial strength of the insurance company issuing the annuity. You want to be sure the company will still be around, and financially sound, during your payout phase.
Variable annuities have a number of features that you need to understand before you invest. Understand that variable annuities are designed as an investment for long-term goals, such as retirement. They are not suitable for short-term goals because you typically will pay substantial taxes and charges or other penalties if you withdraw your money early. Variable annuities also involve investment risks, just as mutual funds do.
How To Buy And Sell Annuities
Insurance companies sell annuities, as do some banks, brokerage firms, and mutual fund companies. Make sure you read and understand your annuity contract. All fees should be clearly stated in the contract. Your most important source of information about investment options within a variable annuity is the mutual fund prospectus. Request prospectuses for all the mutual fund options you might want to select. Read the prospectuses carefully before you decide how to allocate your purchase payments among the investment options.
Realize that if you are investing in a variable annuity through a tax-advantaged retirement plan, such as a 401(k) plan or an Individual Retirement Account, you will get no additional tax advantages from a variable annuity. In such cases, consider buying a variable annuity only if it makes sense because of the annuity’s other features.
Note that if you sell or withdraw money from a variable annuity too soon after your purchase, the insurance company will impose a “surrender charge.” This is a type of sales charge that applies in the «surrender period,» typically six to eight years after you buy the annuity. Surrender charges will reduce the value of — and the return on — your investment.
You will pay several charges when you invest in a variable annuity. Be sure you understand all charges before you invest. Besides surrender charges, there are a number of other charges, including:
- Mortality and expense risk charge. This charge is equal to a certain percentage of your account value, typically about 1.25% per year. This charge pays the issuer for the insurance risk it assumes under the annuity contract. The profit from this charge sometimes is used to pay a commission to the person who sold you the annuity.
- Administrative fees. The issuer may charge you for record keeping and other administrative expenses. This may be a flat annual fee, or a percentage of your account value.
- Underlying fund expenses. In addition to fees charged by the issuer, you will pay the fees and expenses for underlying mutual fund investments.
- Fees and charges for other features. Additional fees typically apply for special features, such as a guaranteed minimum income benefit or long-term care insurance. Initial sales loads, fees for transferring part of your account from one investment option to another, and other fees also may apply.
- Penalties. If you withdraw money from an annuity before you are age 59 ½, you may have to pay a 10% tax penalty to the Internal Revenue Service on top of any taxes you owe on the income.
Variable annuities are considered to be securities. All broker-dealers and investment advisers that sell variable annuities must be registered. Before buying an annuity from a broker or adviser, confirm that they are registered using BrokerCheck.
In most cases, the investments offered within a variable annuity are mutual funds. By law, each mutual fund is required to file a prospectus and regular shareholder reports with the SEC. Before you invest, be sure to read these materials.
What Are Annuity Payments?
Annuities are insurance products that provide long-term income through a stream of future payments. While investment annuities save money for retirement and beneficiaries, structured settlement annuities stem from personal-injury legal cases, wrongful-death claims or lottery payouts. When unexpected circumstances arise and require immediate funds, you can sell these payments for a lump sum of cash.
There are many benefits to these investment products, which is why people planning for retirement, those who win the lottery and recipients of personal injury structured settlements use annuities most frequently. Some of those benefits include:
- Long-term security
- Tax-sheltered growth
- Safe and reliable investment
- Account for longevity
- Avoid probate
- Adjust to inflation
- Care for beneficiaries
- Structure payments around planned expenses
- Maintain an affordable retirement lifestyle
Is an Annuity Right for Me?
Choosing to fund an annuity can be a personal decision. Discuss with your spouse or loved before making this decision. It is also suggested that annuitants consult with an accountant or attorney before making this decision.
View Our Annuity Guide
Consider these questions when talking with your financial advisor:
- What kind of annuity is right for me?
- Have I made maximum contributions to other retirement plans?
- Am I using a highly rated insurance company to buy my annuity?
- What is the cost? Are there any fees?
- Will I need my money sooner than 59 ½ years old?
- Who do I want to leave my assets to?
Should you have any additional questions about annuities, how they work, and the benefits of either type, the Annuity FAQs page can be a useful and comprehensive resource within your search.
Information on Annuity Ownership
If you believe an annuity would be a good investment for you and your family, there are several easy steps to follow to get one:
- Find a Company and Finalize Your Contract – There are a variety of brokers, insurance companies and banks that issue annuities. Look at ratings from Fitch, Standard & Poor’s, AM Best and Moody’s to ensure you choose a reputable company.
- Purchase Your Annuity – An annuity is purchased in one of two ways: as a lump sum or with premiums.
- Lump Sum Payment – For this transaction, an annuity issuer would accept one large payment in exchange for immediate income within a year of purchase. An example of this annuity type is a single premium immediate annuity (SPIA).
- Series of Premiums – When choosing an annuity, owners can contribute a series of payments that will grow tax-deferred over period of years. At a later date, annuity payments will be disbursed to the annuitant. A deferred annuity is an example of this annuity type.
- Receive an Annuity as a Settlement Award – Following a lawsuit for a car accident, product defect or workers’ compensation claim, a court will award an annuity meant to provide for the plaintiff’s long-term financial needs.
Understanding the Major Players
You’ll learn early on there are several key players involved in the annuity purchasing process: the insurance company that distributes the annuity, you as the annuity owner, your beneficiary, and an annuity buyer, should you choose to sell your annuity.
Insurance companies are annuity issuers. These businesses work with brokers, courts and individual buyers to create individually tailored annuity contracts, providing consumers with savings and investment options. They accept premiums, invest some of the funds, and over time provide annuitants with income through a series of payments.
Individuals or defendants pay premiums to insurance companies. The insurance company stores the money in tax-sheltered, interest-growing accounts. At a scheduled time, the owner of the account (which can be you or someone you assign to receive payments) receives cash in a lump sum or through a stream of payments which, in some cases, last through retirement.
Annuity buyers purchase future annuity payments in exchange for advancing cash. They work as a middleman, navigating between annuitants who need money now and companies scheduled to make payments in the future. This arena for selling payments—made up of annuity owners and buyers—is known as the secondary market.
When the owner of an annuity dies, remaining payments often transfer to a spouse or beneficiary. Every annuity contract includes a different set of rules to determine how many payments, if any, are passed on and who will receive them. Riders can also be purchased to increase the amount inherited. Designating a beneficiary helps to avoid a lengthy probate process and prevents remaining assets from being forfeited to an insurance company.
Pros & Cons of Annuities
There are a number of annuity options available to fit your financial needs, all of which have different benefits and functions. We can provide you with an in-depth look at how annuities work, the various types of annuities available to fit your financial needs, and how to sell your annuity payments in the event you need immediate access to cash. Continue reading for a peek at each annuity topic.
In addition, if you are grappling with the idea of buying or selling your annuity investment, but are unsure of the process, we can help to guide you on your financial journey.
Annuities can be useful in the right circumstances. You should be aware of all their available benefits, as well as their risks and drawbacks.
- Your money can grow tax-deferred. This means you are spared from paying taxes on the principal growth until you receive income from your annuity.
- Safe investments generally backed by established insurance companies.
- Allows income for life, especially useful if you outlive your other available assets.
- Guaranteed against loss by taking risk out of your hands and transferring it to an insurance company, unless you choose to invest in a variable annuity in which you carry some of the risk.
- Timed payments minimize taxes.
- Can be combined with other retirement benefits like a 401(k) or Social Security to pay for medical costs, living expenses and vacations to visit the grandkids.
- Provides income that allows you to put off other retirement benefits, such as Social Security payments, until you truly need them.
- Death benefits allow your money to quickly transfer to a loved one after you die, skipping probate.
- Annuities are another way to contribute to retirement funding if you’ve maxed out contributions to a 401(k) or IRA.
- Complex financial instruments with expensive fees, commissions and administrative charges.
- Your money is locked in for a certain period of time.
- Surrender charges and IRS penalties applied when withdrawing funds before age 59 ½.
- Relinquish the lump-sum payment option when you buy an immediate annuity or annuitize your deferred annuity contract.
- Taxes applied to annuity payments may be higher in the future than they are now.
- Not insured by the FDIC or NCUA.
- Capital gains on annuities are not tax-deferred and are subject to regular income tax.
How Do Annuities Work?
Annuity owners pay an insurance company regular premium payments or a one-time lump sum in exchange for steady income payments that can last for the rest of their life or a fixed amount of years. For example, a $100,000 annuity can provide an annuitant with about $630 monthly, or about $7,600 yearly. Unlike a 401(k) or IRA, there is no limit to the amount you may put into an annuity.
Annuity savings grow tax-free and come with little to no risk.
Insurers will work one-on-one with you to set up a schedule tailored to your individual needs. If you want income immediately, plan for payments to start in a matter of months. However, if funds are withdrawn before the age of 59 ½, you will be subject to a 10 percent penalty tax or early withdrawal fee. If you want income once retirement begins, you can initiate payments decades after purchasing. In exchange for securing your finances, you can incur penalties or fees when trying to deduct funds early.
For more information on how annuities work, visit our pages on the following subtopics:
- Taxes on Annuities
- Beneficiaries, Inheritance & Death Benefits
- Divorce Laws
Buying, Splitting and Selling Annuities
While purchasing an annuity may have been a profitable financial option initially, needs can change over time. In addition to investing in this financial vehicle, annuities can be split and sold.
It is not uncommon for annuities to be shared or jointly owned between two parties. But just as they can be shared, annuities can also be split. This is a common option for divorcing couples, as they choose to split their remaining financial assets and marital property. Splitting an annuity is a complicated process that requires the original annuity contract to be split evenly into two new, identical contracts.
If buying or splitting an annuity are not ideal options for you, there is also the decision to sell your annuity. In the event that you need cash now, you can sell a portion or all of your annuity payments for a lump sum of cash. No matter how you choose to sell your annuity contract, the transaction does require court approval. It is also important to discuss all of your options with a financial advisor prior to making the decision to sell.
Get a guaranteed income
An annuity pays you a guaranteed income for a set period of time. You can choose whether you want the payments to last a lifetime or a fixed number of years. Unlike other retirement phase income products, annuities give you certainty, you know how much you’ll get and how long it will last.
How annuities work
You can buy an annuity (also known as a lifetime or fixed-term pension) from a super fund or life insurance company with a lump sum from your super or other savings. If you’re using super money you must have reached your preservation age and met a condition of release.
How much income will I receive from an annuity?
The income you will receive is fixed when you purchase the annuity, however it can be indexed each year, either by a fixed percentage or in line with inflation.
How often are annuity income payments made?
Income payments can usually be made monthly, quarterly, half-yearly or yearly.
How long do income payments last?
When you purchase the annuity you will choose whether you want the payments to last for the rest of your life, your life expectancy or a fixed number of years.
What happens to my annuity when I die?
If you nominated a ‘reversionary beneficiary’ then the income stream payments will continue to be paid to your nominated beneficiary, such as your spouse or dependant. Usually they will receive a reduced level of income payments from what you received. For example if you bought an annuity and nominated your spouse as the reversionary beneficiary, they might continue to receive 60% of your income for the rest of their life, after you have passed on.
Alternatively, you can choose the guaranteed period option. If you die within the specified guaranteed period, your beneficiary will receive the remaining income payments as an income stream or lump sum. Unlike the reversionary beneficiary option, the income payments received under a guaranteed period will not reduce and are only paid for the guaranteed period.
Will I qualify for the Age pension if I receive income from an annuity?
Your Age pension entitlement is determined by an income test and an assets test. The balance of your annuity will be assessed under the Centrelink assets test. Part of the income you get each financial year will be assessed under the income test. The test that results in the lowest Age pension being paid to you is the one that Centrelink will apply. Contact a Department of Human Services’ Financial Information Service (FIS) officer to find out whether an annuity will affect your Age pension entitlement. See social security for more details.
New transfer balance cap
On 1 July 2017 a cap was put on the amount of money can be transferred to a tax-free account-based pension or annuity. The new limit is known as the ‘transfer balance cap’ and it has initially been set at $1.6 million. Details of the changes can be found on the Australian Tax Office (ATO)website.
Benefits of annuities
An annuity is a way of receiving a regular guaranteed income after you have retired from work. Benefits include:
- You are paid a guaranteed income regardless of how markets perform
- Annuities purchased with super money are tax free from age 60
- Annuities purchased with super money before age 60 will have the taxable portion taxed at your marginal tax rate, however, you will receive a 15% offset.
- Only the income component (if any) of an annuity purchased with non-super money is taxable
- You don’t pay tax on investment earnings
- Income payments can be set to increase annually at the time the annuity is purchased
Case study: Peter chooses a lifetime annuity with a guaranteed period
Peter is 65 and married. He invests $200,000 in an annuity which will pay him a regular income of $800 each month, increasing with inflation each year, for the rest of his life. Peter likes that the annuity has a 15 year guaranteed period, which ensures his wife Christine will receive his income payment for a while should he die during that period.
Drawbacks of annuities
There are a couple of things to be aware of before you start an annuity:
- You cannot take out your money as a lump sum
- You cannot choose how your money is invested
- You may not be able to transfer it somewhere else if you change your mind
- Over the long term, an annuity may pay less than a market-linked investment
An annuity is a good choice if you want the security of a guaranteed income for a certain period of time. Seek financial advice from a licensed adviser if you’re not sure if this is the right choice for you.
Annuities – the basics
Annuities are retirement income products sold by insurance companies.
- Lifetime annuities – which pay you an income for life, and will pay a nominated beneficiary an income for life after you die if you choose this option; they include basic lifetime annuities and investment-linked annuities
- Fixed-term annuities – which pay an income for a set period, usually five or ten years, and then a ‘maturity amount’ at the end that you can use to buy another retirement income product or take as cash
When you use money from your pension pot to buy an annuity you can take up to a quarter (25%) of the amount as tax-free cash.
You then use the rest to buy the annuity and the income you receive is taxed as normal income.
How much retirement income you will get from an annuity – and for how long ,will depend on:
- Your health and lifestyle
- How big your pension pot is
- Annuity rates at the time you buy
- Where you expect to live when you retire
- Where you expect to live when you retire
- How old you are when you buy your annuity
- Which annuity type, income options and features you choose
Once you buy an annuity you can’t change your mind, so it’s important to get help and advice before committing to one.
To find out more about the different annuity types – and the different options and features you can choose when buying them – read our guides below.
You’ll also find information on where to get help and advice and how to shop around for an annuity.
- Read our guide on Using your pension pot to buy a lifetime annuity
- Find out more information on Fixed-term annuities
Higher income for medical conditions or unhealthy lifestyle
If you have a medical condition, are overweight or smoke, you might be able to get a higher income by opting for an ‘enhanced’ or ‘impaired life’ annuity.
Not all providers offer these so be sure to shop around if you think you might benefit from one.
Your other retirement income options
An annuity is just one of several options you have for using your pension pot to provide a retirement income.
An annuity is an insurance product that pays out income, and can be used as part of a retirement strategy.
Here’s how an annuity works: you make an investment in the annuity, and it then makes payments to you on a future date or series of dates. The income you receive from an annuity can be doled out monthly, quarterly, annually or even in a lump sum payment.
The size of your payments is determined by a variety of factors, including the length of your payment period.
You can opt to receive payments for the rest of your life, or for a set number of years. How much you receive depends on whether you opt for a guaranteed payout (fixed annuity) or a payout stream determined by the performance of your annuity’s underlying investments (variable annuity).
The biggest advantages annuities offer is that they allow you to sock away a larger amount of cash and defer paying taxes. But annuities have some significant drawbacks. For one, you must be willing to sock away the money for years. If you make a withdrawal within the first five to seven years and you typically will be hit with surrender charges of up to 7% of your investment or more. Annuities frequently charge other high fees as well, usually including an initial commission that can be up to 10% of your investment. If you purchase a variable annuity, ongoing investment management and other fees often amount to 2% to 3% a year.
These fee structures can be complex and unclear. Insurance agents and others who sell them may tout the positive features and downplay the drawbacks, so if you are considering an annuity, make sure that you ask a lot of questions and carefully review the fine print first.
What is an annuity?
An annuity is an insurance product that allows you to swap your pension savings for a guaranteed regular income that will last for the rest of your life.
How much you get is determined by the rate the annuity provider offers.
People who have serious health problems should be offered a higher rate than someone who’s likely to live for many years. The insurer is essentially taking a bet that it won’t end up paying out more than the total pot.
Buying an annuity used to be the only option for most people with a defined contribution pension (where you save into a pension scheme over your working life to build up a pot).
What type of annuity should I buy?
Annuities come in all shapes and sizes, but it’s vital that you pick the right one — because once you buy, you can’t change your mind.
Since April 2015, you’ve been able to withdraw as much of the money as you want when you reach 55 as another option, although it will be taxed as income.
You’ll have to weigh up a number of options that will influence which type you end up buying – if an annuity is the right choice for you.
Key things you should consider when deciding on your pension options (eg an annuity, income drawdown or cashing in your pension) include:
- whether you want protection against inflation
- how much risk you’re prepared to take
- whether anyone else is dependent on you for income
- how much flexibility you need to change your pension after it has started to be paid
- how much control you want over your investments
- what charges you’ll need to pay
- whether you want to provide an inheritance for your survivors
- what your state of health is, and whether you are or have been a smoker.
Always shop around before buying an annuity — it’s an irreversible decision. Find out more about the best ways to do this in our guide to buying an annuity.
How much annuity income will I get?
When you get a quote for an annuity, you’ll be given a rate as a percentage. You base the calculation on your total pot to find out how much retirement income you’ll get every year.
So, if you have £100,000 in your pension pot and are offered an annuity rate of 5.0%, you’ll get an annual income of around £5,000 a year. See our example, right, and a member’s story, below.
In our example, Caroline can expect to live an extra 21 years (a 65-year-old man could expect another 19).
You’ll generally find that the older you are when you arrange an annuity, the higher the annuity rate you’ll get from your chosen provider. Money can be paid monthly, quarterly, half-yearly or yearly, depending on your company.
These rates are correct as of January 2018 and will vary as gilt prices fluctuate. You can run your own annuity rate comparison using the Money Advice Service annuity calculator.
What annuities are
An annuity is a financial product sold by an annuity provider, such as a life insurance company, that will pay you guaranteed regular income. An annuity is typically used for retirement purposes.
How annuities work
You can purchase an annuity with a lump sum or through multiple payments over time. The income payments you receive from an annuity are a combination of interest, a return of your capital, and a transfer of capital from annuity holders who die earlier than statistically expected to those who live longer than expected.
The annuity provider pays you regular income payments. You can choose to either receive income payments for a fixed period of time or for as long as you live. Depending on the type of annuity you choose, you can receive income payments monthly, every three months, every six months or once a year. You can also choose to start receiving your income payments right away, or to have them start at a later date, which is known as a deferred annuity.
The amount of the regular income payment you get depends on a number of things, such as:
- if you are male or female
- your age and your health when you purchase the annuity
- the amount of money you invest in the annuity
- the type of annuity you purchase
- whether your annuity has a guarantee option, which will continue to make payment to a beneficiary or your estate after you die
- the length of time you want to receive payments from your annuity
- the rates of interest when you buy your annuity
- the annuity provider
Types of annuities
There are several kinds of annuities. It is important to understand each type of annuity and what options, benefits and risks each type presents.
Before you buy an annuity, you need to decide:
- whether or not you want the annuity to continue to be paid to a beneficiary after you die
- whether you want regular income payment or income payment that will increase or decrease regularly
A life annuity is an annuity that provides you with a guaranteed lifetime income. For example, if you buy a life annuity for $100,000 at age 65 with an income of $500 per month, you get your $100,000 back by age 82. If you live past 82, you will still receive $500 a month as long as you live.
|Age of annuitant||Number of monthly payments||Amount paid to buy the annuity||Amount received as income payments||Amount gained or lost|
As this table shows, the longer you live, the more income your annuity provides.
In most cases, your life annuity income payments stop when you die and no money goes to your estate or a named beneficiary.
However, some annuity providers may offer the following options so that payments continue to be made after you die:
- a joint and survivor option, where the income payments continue as long as one of the annuitants is alive
- a guarantee option, where income payments are continued to a beneficiary or your estate if you die within a specific amount of time
- a cash-back option, which provides a one-time payment to a beneficiary or your estate if you die before receiving a specific amount of money (usually the amount you paid for your annuity)
These options can be combined, but each additional feature will lower the amount of your income payment.
A term-certain annuity is an annuity that provides guaranteed income payment for a fixed period of time (term). If you die before the end of the term, your beneficiary or estate will continue to receive regular income payments, or receive the balance of the regular payments as a lump-sum.
|Length of annuity term (years)||Number of monthly payments||Regular monthly payment||Total amount received|
This table shows that your regular income payment will usually be lower when you buy an annuity with a longer guaranteed payment term. In addition, the longer your annuity term, the more money you or your beneficiary will make on your original $100,000 investment.
A variable annuity is an annuity where the annuity provider invests your money in a product with a variable return, such as equities. You receive a fixed income as well as a variable income. The fixed income portion you receive from a variable annuity is usually lower than what you would earn with a non-variable annuity, such as a life or term-certain annuity. The variable portion you receive will fluctuate based on the performance of the investment. This means that you could earn more money if the investments perform well, and less money if they perform poorly. This is in contrast with a non-variable annuity, which provides guaranteed income payments regardless of what happens in the market.
Comparing different types of annuities
Annuities offer different options, pay close attention to the pros and cons of each.
A life annuity is an annuity that provides you with a guaranteed lifetime income.
The pros and cons include:
- provides guaranteed income payments for as long as you live
- no risk of outliving your income
- you can add a joint and survivor option to transfer payments to your spouse/partner
- other options can be added to provide money to your beneficiary or estate when you die
- you may pass away before receiving all of your money back
- adding extra options (such as those that provide payments to your spouse when you die) usually means a lower regular payment
A term-certain annuity is an annuity that provides guaranteed income payment for a fixed period of time.
The pros and cons include:
- provides a guaranteed income for a set period of time
- your beneficiary or estate will receive any remaining benefit if you die before the end of the term
- you may live longer than the term of your annuity, meaning you could stop receiving income before you die
A variable annuity is an annuity where the annuity provider invests your money in a product with a variable return, such as equities.
The pros and cons include:
- offers a fixed income plus potential extra income linked to market performance
- you may earn more money than a non-variable life annuity if the investments backing the variable portion of your annuity perform well
- your regular income is harder to predict
- you may earn less money than a non-variable life annuity if the investments backing the variable portion perform poorly
What to consider before buying an annuity
Before buying an annuity, it’s a good idea to take the following into consideration.
When to buy an annuity
If you choose to purchase an annuity, the best time to buy depends on your personal income needs and sources of income.
For example, you may want more money early in your retirement to help pay for travel or new hobbies. Or you may want more guaranteed income later in your retirement years to help pay for the cost of extra health care or accommodations.
If you want more money later in your retirement then you might want to consider waiting to buy an annuity, or purchase an annuity with deferred payments. This means that you pay for the annuity ahead of time but won’t start receiving payments right away. Deferred life annuities provide higher regular payments than immediate life annuities. This is because you will receive fewer payments during your life.
If you are thinking about buying an annuity, consider speaking with a financial professional for help figuring out what the appropriate features are for you, when to buy it and when to start receiving payments.
Your other sources of retirement income
Your retirement income may come from a number of places.
This may include:
- an employer pension plan
- registered savings vehicles, such as a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA)
- public pensions and benefits, such as Old Age Security (OAS), the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP)
- personal savings and investments
An annuity provides you with a regular income during your retirement years. This can make it easier to create a budget and manage your money, especially if you don’t have another regular source of retirement income. For example, you may want to buy an annuity with money from a defined contribution employer pension plan.
An annuity may not be the best option for you if your regular income and savings will already cover your expenses when you retire. You should speak with a financial professional to help figure out whether you will have enough money available to meet your needs when you retire.
The overall price you pay for an annuity can vary between providers
Annuity providers may offer you different income payments for the same type of annuity.
This is because the annuity provider calculates the amount of monthly income they can provide based on several factors such as:
- the type of annuity (fixed or variable) that you choose
- the term of the annuity that you choose (life-only, joint life, term certain)
- your age and gender (so they can estimate your life expectancy)
- their operating costs
- the return they expect to receive on their investments
Before purchasing an annuity, ask for a complete listing of fees and commissions. Make sure you understand contract restrictions, including penalties and administrative fees.
Once you think you know what kind of annuity you are interested in purchasing, it is a good idea to compare similar products from several providers.
Whether you want to leave money to a beneficiary or your estate
If you want to leave money to your estate or a beneficiary when you die, you may want to consider buying a term-certain annuity or a life annuity with either a joint and survivor option or a guaranteed payment period.
The annuity option is not the only option. For example, you can keep some of your money in an account or product other than an annuity, like in a personal savings account or TFSA or a Registered Retirement Income Fund (RRIF). Otherwise, you may not be able to do so with a standard life annuity.
Learn more about making a will and planning your estate.
You may lose money
You will receive more money from a life annuity the longer you live. However, you may not live long enough to get all of the money you paid to buy the annuity in the first place.
Annuities may require a large investment
You may need a large amount of money to buy an annuity. For example, many annuity providers may ask that you invest $50,000 or more to buy an annuity.
Tax implications on annuities
You will have to report the money you get from an annuity as income when you file your taxes. You may have to pay tax on this money. The amount of tax you may pay will vary depending on whether you buy your annuity using money from a registered savings plan, like an RRSP or RRIF, or a non-registered plan, like a personal savings account.
Learn more about taxes and annuities.
How your annuity income is protected
Canadian life insurance companies are required to be members of a consumer protection agency called Assuris. Assuris protects policyholders up to a certain amount in the event that the annuity provider is unable to pay. This means that you will continue to receive at least some of your money if your life insurance company goes out of business.
The income you receive from an annuity covered by Assuris is insured as follows:
- at 100% for monthly payments up to $2,000
- at 85% for monthly payments above $2,000
For example, if your regular annuity income is $1,500 per month then you will continue to receive the full amount as this is less than $2,000. If your regular annuity income is $3,000 per month, then you will continue to receive 85% of this amount, or $2,550.
Learn what organizations are members of Assuris.
Annuities cannot be changed or cancelled easily
To buy an annuity you enter into a contract with the annuity provider. Typically, once you buy an annuity, the terms of the contract can’t be changed. This means you can’t switch to a different type of annuity or get your money back.
Your annuity contract may have a cooling-off period. This means that you can cancel the contract without having to pay a penalty within a specific amount of time. Be sure to read your annuity contract carefully to see if it includes a cooling-off period.
You may have the option under the contract to cancel your annuity within a certain time period after you start receiving payments. Typically, there is a fee to do this which can be a percentage of the purchase price of the annuity.
Speak with your annuity provider for more information about the contract and your rights to change or cancel an annuity.
Annuities are investment options designed to grow funds and then provide a stream of payments to the investor at a later time. They are the protect and spend portion of a financial plan and are commonly used as a way to secure a steady cash flow for retirement.
Penn Mutual offers a number of options that can be structured in ways that suit your specific needs:
Immediate annuities are purchased with a single payment, and immediately provide an income stream. The income stream is determined by the amount of initial payment, the length of time that the payout will continue, and the number of lives being covered.
Fixed Annuities are a simple, low-risk retirement planning vehicle that helps you protect your principal and allow your investment to grow over time. Your retirement savings are credited with interest at a rate guaranteed never to fall below a stated rate. Your savings can receive credited interest until you decide to receive a stream of payments.
Variable annuities offer a wide array of investment options that allow you to customize your investment strategy to meet your needs and risk tolerance. Variable annuities also provide protection options to safeguard against inflation and market volatility. A variable annuity is a long-term financial retirement vehicle that offers the greatest growth potential but is subject to market fluctuations and may lose value.
All Guarantees are based on the claim paying ability of the issuer.