What is a life insurance annuity?
A life annuity is an insurance product that features periodic payouts until the death of the annuitant. Holders of annuities pay into the annuity on a periodic basis while they are still working, but they can also make a lump sum purchase and buy the policy outright. When the annuitant retires, the annuity makes periodic payments to the annuitant. These payments most commonly occur on a monthly basis, and the payments ensure that the annuitant can maintain a certain standard of living into old age. Life annuities will cease periodic payments when a triggering event such as a death occurs.
Who should consider life insurance annuities?
These types of financial products are useful for people planning for retirement, as the payouts from a life insurance annuity can help you live comfortably after you stop working. Life insurance annuities can act as great financial safety nets, as having a guaranteed supplemental income makes retirement less stressful. There are many life annuity policies available for potential annuitants to choose from, so it is important to weigh your options.
How do annuities work?
Annuities can be purchased from a super fund or a life insurance company. Here are some important pieces of information about life annuity insurance:
- How much income will you receive? The amount of income you receive from your annuity is fixed at the time of purchase of the policy. The income can be indexed each year by a fixed percentage or in line with inflation.
- How often are income payments made? Income payments can be set up on a monthly, quarterly or half-yearly basis.
- How long do income payments last? You can choose to have income payments be made for a fixed number of years or for the rest of your lifetime. This decision is made when you purchase the annuity.
- What happens if you die? There are two common options you can utilise so your beneficiaries are covered when you pass away. The first one is opting into a ‘revisionary’ income stream. Payments will still be paid to a beneficiary when you die, but the payments will not be of the same level of income that you personally collected while alive.
The other alternative is choosing a guaranteed period option. If you die within the specified guaranteed period, your beneficiary will receive the remaining payments as an ongoing income stream or as a lump sum. These payments are not reduced, but they are only paid for the guaranteed period.
Annuities and allocated pensions: how do they differ?
- Annuities: Annuities are financial products that are purchased from a life insurance company using super or normal savings. They provide a guaranteed series of payments over an agreed period of time. The major difference between annuities and allocated pensions is that annuities are less flexible. You cannot make lump sum withdrawals and the fund manager decides how your money is invested. Annuities tend to pay less than market-linked investments and take a more metered investment strategy. They are a very safe investment and can give you the peace of mind that a guaranteed income brings without having to worry about the ups and downs of the financial market.
- Allocated Pensions: Allocated pensions (also known as account based pensions) provide you with a series of recurring payments that are drawn from money transferred from a super fund. These payments are subject to minimums that are calculated as a percentage of the account balance. There is certainly more flexibility with allocated pensions, as you can take out as much money in annual payments as you want and you have the ability to take out lump sum amounts. There is also the handy ability to roll amounts back into a super fund.
With an allocated pension you are in charge of selecting the investment strategy. This means that your money will be affected by market returns. The money is not guaranteed for any specific period of time as a result. Like annuities though, allocated pensions can provide income payments to your beneficiaries after you die.
What happens to the annuity if the owner dies?
It is important to understand just how your annuity is structured in case of your death.
- If you die before the income payment period: If you pass away at an early age your money will go to the annuity provider. You can have a minimum payment term as part of the annuity contract that will allow your spouse or dependents to receive payments for the rest of the term outlined in the contract. They may also be paid in a lump sum.
- Reversionary annuity: A reversionary annuity is a financial product that allows your beneficiary to get income payments after you pass away. This type of annuity is much more costly than an annuity which does not have a reversionary period. Also the payments received by your beneficiaries are often a lower amount than the payments you receive when alive.
- Guaranteed period option: A guaranteed period option in the contract of an annuity will allow your beneficiary to receive the remaining income payments as an income stream or a lump sum. These payments are of the same monetary amount as the payments the policyholder receives while they are alive, but are only paid out for the remainder of the guaranteed period. These payments are also contingent upon the policyholder dying within the guaranteed period.
How is an annuity different than life insurance?
Life insurance and an annuity both contain some similar features, but they each play a different role in your financial portfolio. Life insurance provides money to your loved ones when you die to help them pay for funeral expenses, any outstanding bills or other financial obligations you want to fulfill upon death. Annuities on the other hand provide savings for retirement to help you and your family live more comfortably.
Here are a few major differences between the two:
|Life annuity||Life insurance|
|Is there a death benefit?||You are paid out the amount you have paid in premiums plus any interest accrued||You are paid out a sum agreed on when you apply|
|Can it be build up as savings?||Yes||No|
|Are there tax benefits?||Any interest that accrued is subject to tax||Tax-free benefit|
How much do annuities cost?
Annuity costs can be difficult to determine because the level of annual income you receive is based on investment costs, investment risk, profit for the annuity operator and the various administrative and marketing costs. Providers will promise a certain return on your money, and this promise of return is calculated after taking costs into account. This means that you will not generally be paying for annuity costs right out of your income payments. You will still be paid the promised return on your money regardless of whether the provider makes more or less than what they promise to you. Different providers will offer up annuities with different cost structures.