Annuities – What You Need to Know

Nov. 29

KEY POINTS

Income Assurance with Versatility
Annuities offer a unique blend of insurance and investment, providing a dependable income stream. They adapt to diverse risk preferences, offering a versatile solution for financial planning.
Comprehensive Benefits for Diverse Needs
Whether planning for retirement, covering healthcare expenses, or ensuring a financial legacy, annuities address a spectrum of individual and business financial needs.

Did you know?

$281-345 billion annual annuity market is forecasted from 2023-2027 (Life Insurance Marketing Research Association (“LIMRA”))
The majority of annuity purchases are by individuals aged 55-70 (LIMRA)
In 2024, the U.S. will have more 65-year-olds than ever before (National Association for Fixed Annuities (“NAFA”))
In 2020, 4% of private sector workers will have a company pension plan vs. 60% in 1980. (NAFA)

What is an annuity?

The inclusion of annuities to your investment strategy can be an important step in your estate planning process and integrated insurance strategy.

An annuity is a financial product incorporating elements of insurance, structured to deliver a consistent income stream over a specified period or the entire lifetime of the annuitant.

Typically acquired from an insurance company, an annuity involves the annuitant making either a lump sum payment or a series of contributions. In return, the insurance company commits to providing regular payments, ensuring a predictable income.

This insurance aspect is particularly evident in the life annuity, where payments continue until the annuitant's death, offering a form of longevity protection. This combination of financial and insurance features makes annuities a versatile tool for individuals aiming to secure a reliable income, particularly in retirement.

Types of Annuities

There are 3 main types of annuities, providing planning flexibility. Each possesses its own unique investment and interest rate structure.

Fixed Annuities

Offer a consistent, predetermined interest rate for a specified period. This provides a stable income stream and protects the annuitant from market volatility. While returns may be lower compared to other types, the fixed nature appeals to individuals seeking financial predictability.

Variable Annuities

Allow annuitants to invest in a range of sub-accounts, similar to mutual funds. The returns are not fixed and depend on the performance of the chosen investments.

This flexibility exposes annuitants to market risks but also provides the potential for higher returns, making variable annuities suitable for those comfortable with investment fluctuations.

Indexed Annuities

Combining features of both fixed and variable annuities, indexed annuities link returns to a specific market index (e.g., S&P 500).

While there is potential for increased returns based on market performance, there is often a minimum guaranteed interest rate, offering a balance between market participation and principal protection.

However, upside performance potential may be subject to participation caps that vary by financial provider and policy.

Annuity Cash Flows

Payments for each of the described annuities can be either immediate or deferred in their timing structure.

Immediate Annuities

Immediate annuities begin providing regular payments shortly after the annuitant makes a lump sum payment. This type is advantageous for those seeking an immediate income stream, often used by retirees to cover living expenses.

Deferred Annuities

Deferred annuities involve a waiting period between the initial contribution and the commencement of payments. During this accumulation phase, the annuity grows tax-deferred, allowing for potential compound growth before the annuitant begins receiving payments. This type is suitable for individuals planning for future income needs.

Why purchase an annuity?

Individuals and businesses may purchase an annuity for various reasons including:

Individuals

Retirement

An annuity offers a reliable income stream, supplementing pensions and other retirement savings.

Long-Term Care

Cash flows can be used to cover expenses associated with assisted living, nursing care, and other healthcare needs related to aging.

Education Funding

Students often ask,

Is the cost of a college degree worth the student loans?

Annuities can play a role in reducing the need for student loans.

Proceeds can be directed towards covering tuition fees, purchasing books, providing housing, and meeting other essential expenses for supporting a child’s education.

Businesses

Pension Plan Funding

Annuity cash flows play a crucial role in ensuring a consistent funding source, meeting pension obligations, and providing financial security to retirees.

Debt Repayment

Cash flows can be utilized in a structured manner to service existing debt.

Employee Benefits Funding

A well-devised strategic plan, incorporating appropriate annuities, can partially or fully cover commitments such as health insurance and profit-sharing, benefiting both the employer and the employees.

Annuity Benefits

Annuities provide valuable benefits including, but not limited to:

Guaranteed Income Stream

Annuities can provide a consistent and reliable income stream.

Longevity Protection

Annuities can be designed to provide a guaranteed income stream for the entirety of an individual's life, ensuring financial security throughout retirement. This longevity protection is particularly important for retirees concerned about outliving their savings.

Risk Mitigation

They can offer a degree of protection against market volatility, offering a stable return on investment. This risk-mitigating aspect is particularly appealing to those who want to minimize the impact of unpredictable market fluctuations, providing a sense of security in their financial planning.

Tax Advantages

Some annuities come with tax benefits, allowing for tax-deferred growth on the investment. This means that individuals or companies can potentially reduce their tax liability while the annuity grows, providing a tax-efficient way to accumulate wealth over time.

Long-Term Care Planning

Certain annuities offer riders or features that can be utilized to cover long-term care expenses. This is particularly valuable for individuals concerned about the potential financial impact of healthcare needs in the later stages of life.

Principal Protection

Fixed annuities guarantee the return of the principal amount, making them a conservative investment option. This is attractive to those who prioritize protecting their initial investment over higher-risk, potentially higher-reward alternatives.

Estate Planning

Annuities can be structured to facilitate efficient wealth transfer to beneficiaries, avoiding probate and streamlining the distribution of assets. This makes them a valuable tool for individuals looking to leave a financial legacy for their loved ones.

Inflation Protection

Some annuities offer features such as cost-of-living adjustments, allowing income payments to increase over time to counter the effects of inflation. This ensures that the purchasing power of the annuitant is maintained over the long term.

Flexible Payout Options

Annuities come with a variety of payout options, allowing individuals to tailor their income distribution to their specific financial needs. This flexibility is crucial for adapting to changing circumstances or unexpected expenses.

Diversification

Annuities can serve as a stable component within a diversified investment portfolio. This diversification helps manage risk by balancing more volatile assets with the stability provided by the annuity, contributing to a well-rounded and resilient financial strategy.

Creditor Protection

Some annuities may provide a degree of protection from creditors. Such will vary by jurisdiction and the type of annuity.

Risks and Limitations

Although the benefits of annuities can be compelling, investors should be aware of potential risks associated with investing in annuities. Such may include, but is not limited to,

Lack of Liquidity

Typically, annuities come with surrender charges and withdrawal penalties. The associated limited access to funds can be a significant drawback during financial emergencies or changing financial plans.

Complex Fee Structure

Annuities may include fees related to annual fees, mortality and expense risk charges, and administrative fees. These fees can reduce the overall returns over time.

It is imperative that you learn how to choose a financial advisor and perform the necessary due diligence to ensure they are independent and aligned with your short-term and long-term goals.

Inflation Risk

As noted above, some annuities will offer inflation protection. For those that do not, the fixed income from an annuity may not be sufficient to maintain the same standard of living over time.

Annuities vs. Life Insurance

The world of insurance can be confusing and complex. It is common to mix up the attributes of annuities and life insurance policies. The following table is designed to provide clarity and promote sound decision making.

Criteria	Annuity	Life Insurance
Purpose	Provide regular income for a specified period or lifetime	Financial protection for beneficiaries in case of the policyholder’s death
Payment Type	Lump sum or periodic payments from the policyholder to the insurer	Premiums paid periodically by the policyholder
Beneficiaries	Typically, can name beneficiaries for the death benefit, but primary focus is on the policyholder’s income	Primarily focused on providing death benefits to beneficiaries
Risk	Generally lower risk as they are designed to provide a steady income stream	Provides financial protection against the financial risks associated with death
Cash Value	Some annuities have a cash value, especially variable annuities	Permanent life insurance policies may accumulate a cash value over time
Death Benefit	Annuities may offer a death benefit, but it is not the primary purpose	Primary function is to provide a death benefit to the beneficiaries
Investment Options	May have various investment options	Whole life and universal life offer investment options
Payout Options	Can choose between various payout options such as life, period certain, or joint and survivor	Death benefit can be paid out as a lump-sum or annuity, depending on the policy terms
Longevity Protection	Provides protection against outliving one’s savings	Provides financial protection for loved ones in the event of the policyholder’s death
Surrender Charges	Early withdrawal may incur surrender charges	Surrender charges may apply on early termination of the policy

Annuities and life insurance policies have different types and variations. The specific terms and conditions can vary significantly between products.

FINAL THOUGHTS

Annuities combine insurance and investment for a reliable income stream. With fixed, variable, and indexed options, they suit various risk preferences, and immediate or deferred choices offer flexibility.

Benefits include guaranteed income, longevity protection, risk mitigation, tax advantages, long-term care planning, principal protection, estate planning, inflation protection, flexible payouts, and portfolio diversification.

Drawbacks may include limited liquidity, complex fees, inflation risk, and more.

The decision to choose annuities depends on individual goals, and understanding these features aids informed decision-making.