Retirement Annuities Demystified

Retirement annuities from an insurance company? "What?! Why would I give my hard earned savings to an insurance company?" That was my reaction when I first learned that annuities were insurance products.

But, they really are investment products offered by insurance companies.

Here's how it works: In exchange for a premium, monthly payments are provided to the covered person (called the annuitant), usually for life, or for a certain period of time.

The purpose of an annuity is to convert a pool of money, referred to as the premium, into an income stream for a period of time, either for the life of the annuitant(s) or for a fixed period of time.

The premiums can be paid to the company over time like a savings deposit, or in a large lump sum. An interest rate is applied to the funds, and it varies along with other interest rates in the then-current market.

When the period of coverage is the life of the annuitant, the investment carries risk in that the full premium is surrendered.

If the annuitant dies earlier than anticipated, the funds have already been surrendered and are not refunded, unless stipulated.

There are riders which can be added to the policy to address this risk and provide guarantee periods where the payments will continue for a minimum fixed period and be passed on to survivors.

Example Annuity Terms

Sample Annuity

Example: This scenario was provided by the immediateannuities.com web site based on interest rates in effect at the time.

Premium: lump sum $250,000
Age of covered person: 55
Gender of covered person: Female
Period of coverage: lifetime
Estimated monthly income provided: $1,150

If we add a rider for a guaranteed period of 20 years, the monthly income will be $1,115.

This guaranteed income would provide a total of $267,600. The income amount to be provided by the annuity is determined using formulas based on the life expectancy of the insured person, their gender, the premium amount, and the current interest rates.

When interest rates are high, annuities can be very attractive alternatives to the risks of the stock market. In the above example, if the covered person (annuitant) lives 30 years, their $250,000 would provide more than $401,000 in total payments.

Personal Pensions

Annuities or annuity formulas are often used to provide for pensions. Insurance companies sometimes market “personal pensions” which are annuities purchased by individuals with their retirement savings.

This may appeal to some people as a conservative investment, but it may not be right in certain market environments such as when interest rates are very low.

Another risk of retirement annuities is the reliance on the insurance company’s ability to pay over the long run. Will this insurance company be around for the 20 or more years that you will be counting on for your income?

This type of investment is not covered by the FDIC, but each state provides some protection from failures of the insurance companies, $100,000 or more.

To investigate annuity products, look at a large well-known insurance company. (One of the largest and oldest annuity providers is TIAA-CREF.)

The best approach is to speak with a knowledgeable financial advisor for more information and specific pros and cons for your situation and the financial climate.

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