Annuities can be extremely multifaceted, which makes it all the more important for financial service professionals to understand them, inside and out. This beginner’s guide to the product will help you educate consumers on the many features, terms, agreements, benefits and costs they need to know about before making a purchase.
What is an annuity?
It is a financial product that provides a stream of payments. These payments are the result of a contract purchased from an insurance company in exchange for a specified sum of money. Payment can be made in a lump sum, with payments beginning immediately. This is known as a single premium immediate annuity.
Another option allows consumers to pay small amounts to an insurance company over a longer period of time. At the end of the savings period, the customer would then begin receiving the payout, or annuity period. This is known as a deferred annuity. This is typical of the annuities used by millions of Americans to fund their retirements.
What makes annuities special? In the entire universe of investment vehicles, they are the one investment that can provide a lifetime stream of income.
In a sense, annuities are the opposite of life insurance. Life insurance protects survivors from the risk of a breadwinner dying too soon and fully providing for them. Annuities, on the other hand, can protect individuals and the surviving spouse from living too long and running out of money in retirement. This is known as longevity risk. In short, life insurance protects one from dying too soon, and annuities protect one from living too long.
Funding and payouts
Annuities can be categorized in a number of ways. As mentioned earlier, they can be categorized by the manner in which they are funded: immediate or deferred. They can also be categorized by the manner in which they pay out their income: straight life or pure annuity. With straight life, payments will be made for as long as the annuitant is living. In the second case—life with 10 years certain—payments are made for as long as the annuitant lives. If, however, the annuitant should pass away within the first decade after the payouts begin, this contract guarantees that payouts will continue for a minimum of 10 years.