Let’s start by addressing a common misunderstanding about annuities. The debate about whether or not they make sense in a low-interest rate environment has nothing to do with short-term interest rates (like the overnight rate, for example). Short-term rates don’t drive annuity prices, long-term rates do. This is because it is long-term rates that determine the return on investment annuities providers can earn to pay the holders of their annuities.
Even when rates are low, annuities are attractive to a lot of investors because they offer a commitment on the part of the financial institution to make regular income payments to the annuitant.
It’s useful to think of annuities as a bet on the part of the financial institution. The bet is that among all of the consumers who buy annuities from them, the payments the company receives plus the interest it can earn investing those funds, will more than make up for the cost of providing each of their customers the promised income payments.
This is one of the things actuaries do. Annuity prices are based on life expectancy rates (i.e. how long the clients will require payment) and long-term interest rates (i.e. how much the financial institution can earn investing those funds). By selling annuities to a large population, the financial institution pools its risk, and a business is created.
That business offers consumers more than a few options.There are term certain annuities, which pay the annuitant a regular income for a period of time. That period can stretch 10 or 20 years, or it can run until the client reaches a certain age. If the annuitant dies before this term ends, the leftover income payments are made to his or her beneficiary.
There are also life annuities, which provide income for the annuitant’s lifetime. Here are four common types:
Straight life annuity. The financial institution commits to regular payments to the client until he or she dies. Payments stop at that time, regardless of when that happens.
Life annuity with a guarantee. In addition to regular payments during the client’s life, the institution commits to a guarantee period. If the client dies before that period is over, the remaining income payments are made to the client’s beneficiary.
Increasing life annuity. Income payments rise over time at a fixed rate, compounded each year. These increases are calculated for as long as the annuitant lives. Guarantee periods are available for these annuities too.
Joint and last survivor annuity. This covers the income needs of two annuitants. After the first dies, payments continue to the second until he or she dies. These come in four forms: 1) with no guarantee period, 2) with a guarantee period, 3) with income reducing (which reduces the income payments after the first annuitant dies) and 4) with income increasing (which increases income payments each year as long as one or both annuitants is alive).
There are other types. Ask Mintco Financial advisors about installment refund, integrated, cash refund, impaired, commutable and variable annuities. It’s also worth asking about deferred annuity options, which allow you to pay in advance of your retirement date. Your funds could earn a return on investment in the meantime, thus increasing your eventual income payments.
One last note. While annuities can play an important part in a retirement plan, clients are rarely advised to annuitize 100% of their retirement savings. Typically, it’s only consumers with very little retirement savings and few resources at their disposal that should consider annuitizing all or a large portion of their savings.
Have questions? Call Mintco Financial Advisors at 813-964-7100 or visit www.mintcofinancial.com
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