Understanding Income Annuities and How They Benefit You
By David Hanzlik
401 (k) s, Roth IRAs, and annuities are all great strategies for helping families plan for their future in retirement, and each has distinct advantages. While the current low interest rate environment may make some of these strategies less attractive, income annuities remain a notable option.
Income annuities offer payments at regular intervals that are set when contracts are issued and can never decline, even in times of economic volatility. For many people, knowing that their income will remain stable even during the most catastrophic stock market crash is the only reason to invest in an income annuity.
That kind of peace of mind and financial certainty could be even more valuable in light of the COVID-19 crisis – a recent CUNA Mutual Group Investigation into Financial Stability in a Pandemic, conducted on 1,000 U.S. adults aged from 18 years of age or older and earning an annual income of between $ 35,000 and $ 99,999, found that 30% of respondents said the pandemic had diminished their financial stability. Other potential benefits of income annuities include helping clients manage longevity risk – the risk of outliving assets – and paying death benefits that create a legacy for loved ones.
But there is not just one type of income annuity …
- The simplest form is a “life only” income annuity, which has no death benefit. Income payments are made while the annuitant is alive and stop when the annuitant dies.
- A “cash refund lifetime” income annuity pays out the same way, but if the annuitant dies before the total payments made equal the principal invested in the contract, the difference will be paid to a beneficiary. This option ensures that the premium is always refunded.
- A third option, “guaranteed life”, means that if a person dies before a certain number of years, their beneficiary receives payment until the end of the period.
- And finally, a fourth option, the “payout” makes payments for a set number of years, but there is no lifetime income guarantee.
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Annuities that offer lifetime income guarantees – all types other than “installment” – are partially paid by mortality credits. Since some people will live longer than their life expectancy – according to life tables – while others will live shorter, those who live shorter than their life expectancy help fund those who live longer. This funding – or earnings paid to those who live longer – is known as mortality credits. Mortality loans are a way to pool risks among participants to generate higher guaranteed income. Mortality loans provide a guaranteed source of income that is much more profitable in today’s low interest rate environment.
This is where a trade-off is made – the more guaranteed the payments, the lower the mortality credits and, therefore, the lower the income payment. The advantage of the “life only” option is to receive the highest possible income, but the disadvantage is that no financial inheritance will be paid to the beneficiaries. Conversely, the “life with cash refund” and “life with guarantee period” options will have lower income payments, but could provide a financial legacy to beneficiaries if the annuitant dies earlier than expected.
By using an income annuity to manage longevity risk and meet basic income needs, the remaining assets can be used for other purposes – like “wants” or unforeseen expenses – without compromising those income needs. based. Ultimately, each individual and their financial advisor must assess how successful different portfolios are in meeting basic income needs, generating cash for other needs or wants, and creating a financial legacy for loved ones. .
About the Author: David Hanzlik
Dave Hanzlik is Vice President of Annuity and Retirement Solutions at CUNA Mutual Group, a leading insurance, financial services and technology company focused on helping people achieve financial security at every stage. of life.
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