An annuity allows you to take a sum of money, and convert it into a guaranteed income stream for the rest of your life. Annuities are available from insurance companies, and the amount of income that a lump sum of money will purchase depends on age at time of purchase, whether it's for a male or female, and if you want any optional features.
Presently, a 65-year old woman with $100,000 can purchase a guaranteed monthly income of approximately $500, payable for life.
While your financial advisor is best able to determine if an annuity makes sense for your situation, here are some details on annuities to get you started...
Firstly, there are some significant benefits to purchasing an annuity to provide retirement income; these include:
- Guarantees: Once the annuity is purchased, the income amount you receive is guaranteed and will be paid for as long as you live.
- Convenience: Rather than taking regular withdrawals from your retirement savings, annuity payments are made regularly, usually monthly, like a paycheque.
- Protection from market risk: An annuity removes the hassle of managing the investment throughout retirement, which can become more and more difficult as you get older.
- Longevity protection: Annuities can be considered insurance against outliving one's resources, as the income stream continues as long as you live. Considering all of these factors, a life annuity can provide significant peace of mind to retirees.
- Tax advantages: Annuities may have preferential tax treatment, when compared to taking the money into income in other ways.
With that said, there are also some factors which make annuities unattractive for some people; these include:
- Low returns: In today's low interest rate environment, the income amounts produced by annuities may look unattractive, and are significantly lower than the income that could have been purchased for the same amount of money 10 or 20 years ago. Compounding this, as people continue to live longer, insurance companies will be paying the income payments for a longer period of time, so this is factored into their calculations.
- Inflexibility: Once an annuity is purchased, there is no access to your lump sum of money — for example, in the case of emergencies when you may need to access more than what the guaranteed income payments provide (although some do offer a cashability feature — see below).
While the standard form of annuity would be for a single life with payments continuing until death, it's important to know what options are available. The impact of selecting any of these optional features is to reduce or increase the guaranteed income amount that is purchased.
These options include:
- Guarantee period: Income payments continue for as long as you live, but a minimum number of payments will be guaranteed. For example, with a 10-year guarantee period, if you died after 5 years, the next 5 years of payments would go to your stated beneficiary.
- Joint: An annuity can be purchased on two lives, and income payments will continue as long as one of the two people is alive.
- Impaired annuity: If you are in poor health, you can ask the insurer to consider this and they may be willing to pay higher income amounts, on the basis that your life expectancy is lower than average.
- Indexation: In order to protect against the effects of inflation, annuity payments may be indexed annually.
- Cashability: An option which allows you to take a withdrawal from your annuity in excess of the regular payments.
Find the solution that's best for you
Annuities are an attractive option for many people entering into retirement, though as with all financial matters, it depends on your personal situation. Always seek advice from a trusted professional to find the solution that's best for you.
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Nothing contained herein is intended to provide personalized financial, legal or tax advice. Before implementing any financial strategy, you should obtain information and advice from your financial, legal and/or tax advisers who are fully aware of your individual circumstances.