Is a Life Annuity Right for You?
March 22, 2017
Ivon T Hughes
Life annuities can be an effective retirement planing tool because they offer investors guaranteed lifetime income in their senior years.
If you really want to get the most out of a life annuity, then you need a fundamental understanding of how they work. In this article we'll run through the basics of a life annuity and then illustrate what happens with a simple example that has all the numbers plugged in.
How Does a Life Annuity Work?
A life annuity is basically a contract provided by a life insurance company that pays investors a guaranteed monthly income for life. No matter how long the investor lives, he or she is guaranteed never to outlive the income from a life annuity. In many ways, it's similar to having a lifetime defined benefit pension plan.
When you buy an annuity, you give the insurance company a lump sum of money. Many investors choose to use the money in their Registered Retirement Savings Plans (RRSP); others may rely on outside assets, such as the sale of a stocks or saving funds. In exchange, the insurance company provides a specified monthly income that is a combination of interest and the principal that was invested. The amount of this income is based on several factors including the investor's:
• Life Expectancy - The income from a life annuity is calculated by actuaries who must consider how long you are likely to live. There is a big difference in income, for example, between male and female investors of the same age. Since women live longer than men, a male investor will get a higher income than a female of the same age and health. The life insurance company expects that the male won't live as long, and they will have to pay income for a shorter period of time. Alternatively it will pay less over a longer period for a female annuitant.
• Age - In general, the older you are, the higher your monthly income.
• Health - The investor's health is also an important factor when determining income. Investors with significant health issues can request a special, higher quote on their annuity.
The biggest advantage to choosing a life annuity for retirement income is the built in guarantees. With a life annuity, investors enjoy peace of mind knowing that their investment income will never drop or change.
Plus, life annuities require little to no management once they are set up so there are no ongoing fees as with a mutual fund.
Peace of mind is knowing that your money is working for you in the most opportune way.
As a life annuity won't come to an end, annuitants are happy to enjoy the security of a guaranteed income! They are paying less tax now on capital and interest than if the taxes were paid when originally due.