Annuity Income Options
by William D. Brownlie, CLU, ChFC, CIP, LIA
An annuity contract is the opposite of a life insurance contract. Life insurance companies issues both: annuities combat the uncertainty of living too long and life insurance dying too soon.
Simply put an annuity is a contract in which an insurance company makes a series of income payments at regular time-periods (monthly, quarterly, or annually) in return for a premium (one-time deposit) or premiums (sequence of payments) you have paid. Only an annuity issued by a life insurance company can guarantee to pay you an income for as long as you live-in other words your income will last as long as you do-you cannot outlive it.
This article will focus on the income producing aspect of an insurance company annuity.
The insurance company annuity offers a variety of guaranteed lifetime income options for you with or without different secured time-periods for the designated beneficiary. The insurance company annuity will be discussed in detail.
This article will not discuss annuities as tax-deferred products that are being used solely to accumulate money. That I will leave to those who recommend this type of a purchase-I do not.
The insurance company annuity alleviates the need for you to become an expert in managing money, which is a basic requirement when producing a stream of retirement income by way of a systematic withdrawal approach from a mutual fund. That expertise requires in-depth knowledge regarding present-value, future-value, time, payment, and interest. These five ABCs of finance are the components, which must be entered into either a hand-held calculator or the proper software in order to compute, a stream of retirement income for X dollars per month for X years.
Systematic Withdrawal Approach Considerations
- Asset allocation: This is very serious business and it requires an expertise that very few have the stomach for.
- Past investment performance: Although an interesting read it is no guarantee as to future results. It does however provide a "frame of reference" in order to make reasonable decisions. I recommend without hesitation that you spend $15 and purchase "Stocks, Bonds, Bills, and Inflation Summary Statistics 1926-1999" from Ibbotson Associates at ibbotson.com
- The constant average interest factor: The monthly income and present-value amounts of money required as calculated by the majority of software and/or hand-held calculators contain a mathematical formula that utilizes a constant average interest factor. This is not reality! When it comes to investing money one should always be mindful of this fact.
- Mental and physical health: Machines wear out…and so do people. Because of this many turn to "bricks, stone, and glass" that is institutions to manage their money.
The Annuitization Principle
Simply put, this is a process whereby your principal e.g., $1,000,000 is converted into a guaranteed monthly payment for as long as you live. As stated previously, as the "bedrock of an annuity" it is impossible under this system for you to outlive your income. It will last as long as you do. This is the essential reason why insurance companies believe that their annuity is the choice over any alternative approach. It avoids all of the negative aspects of the systematic withdrawal method, and could provide some of the positives. On the other hand, insurance companies being in the money management business as owners of broker-dealers offer systematic withdrawal methods through their registered representatives and/or registered investment advisers.
Consumers have overlooked this time-honored principle of "annuity income" as the financial markets have soared into new highs. This type of a continuing economic attitude depends on an ongoing market boom to keep people clear of the barriers in their path to a stream of retirement income.
Insurance Company Annuity Income Options
- Installment Payment-Fixed Amount: You determine the amount of money that you want to receive each month. The insurance company will tell you how long it will be paid. The payment will be made whether you live or die.
- Installment Payment-Fixed Period: You determine the length of time that you want to receive a monthly check. The insurance company will tell you how much it can pay for the time-period you have selected. The payment will be made whether you live or die.
- Life Annuity This insurance company annuity option provides the maximum amount of monthly income that you can receive-because it dies with you.
- Life Annuity with a Guaranteed Time-Period: This insurance company annuity option provides you with a monthly income for the guaranteed period elected and thereafter for your remaining lifetime. The period elected may be 5, 10, 15, or 20 years. If you should die before the end of the guaranteed period, the insurance company will pay the remaining guaranteed payments to a successor beneficiary or to your estate.
- Life Annuity with a Refund: This insurance company annuity option provides you with a monthly income for a guaranteed period and thereafter for your remaining lifetime. If you should die before the total of your annuity payments equals the annuity's purchase price, the insurance company will pay the difference to a successor beneficiary or to your estate.
- Joint & Survivor Annuity for Life: This insurance company annuity option provides you and a 2nd person with a monthly income while both of you are living. Upon the death of either one of you, the income will continue during the lifetime of the surviving person. The surviving person's income will be a percentage of the full amount chosen at the time of election of this option. Typical percentages available are 50 percent, 66 2/3 percent, 75 percent and 100 percent. Payments terminate automatically and immediately upon the death of the surviving person without regard to the number or total amount of payments received.
- Joint and Survivor Annuity with a Guaranteed Time-Period: This is similar to the Joint & Survivor Annuity except that for this option, the proceeds are to provide equal monthly payments for the guaranteed period (e.g., 20 years) and so long thereafter as either you or the 2nd person is living.
William D. Brownlie, CLU, ChFC, CIP, LIA is the author of Life Insurance Boot Camp Buyer's Guide. This article is based on condensed material from Chapter 19.