How does an annuity work?

How does an annuity work?

An annuity is essentially a series of payments that are made to the individual to provide greater financial security on the approach to retirement. Purchased using the funds from your pension plan, this income is either paid for life or a set period of time.

There isn't one specific type of annuity available. A life annuity provides the annuitant (the individual who receives the payment) with a guaranteed monthly payment for life. The longer you live, the more money you will receive and your beneficiaries could also benefit. Whilst most companies will pay the amount on a monthly basis, some may offer quarterly, semi-annually, or annual plans allowing you to select the most appropriate option for your circumstances.

A term certain annuity, also known as a 'fixed-term annuity', provides a guaranteed income over a set amount of time.

Variable Annuities

A variable annuity refers to a contract between your insurance company and yourself. This contract provides you with greater freedom to invest in products such as equities which may see you benefit from a variable return. The amount of money that you earn from your investments is going to be dependent on how well they perform.

Ensuring that you are aware of what is involved with purchasing an annuity is crucial. Carefully acknowledging the benefits and drawbacks of each option available to you will help you select the most appropriate option for your requirements. The purpose of an annuity is essential to transfer the risk from yourself to an insurance company should you outlive your other income.

You can choose to invest in an annuity to receive your payments immediately or you can select a deferred annuity. An annuity of this kind makes sure that you have your annuity prepared in advance though you will not receive your payments until a later time.

The Factors that can affect your annuity

• The type of annuity you buy; life annuity, term annuity, and variable annuity and the amount that you invest in your annuity.
• If you purchase your annuity at an older age, you will receive higher payments. Your gender can also be influential. Men typically tend to get more money than women who are the same age as women are expected to live longer.
• Length of the term that you choose to receive your payments (applicable to a term annuity, a life guaranteed annuity). If you opt to receive the payments within a shorter term, the amount that you receive is likely to be higher. A lifetime annuity will provide a guaranteed lifetime income until you pass away.
• Depending on your contract, payments from your life annuity may continue to be paid to a beneficiary following your passing. A life annuity typically stops paying when the annuitant has died. Some will provide options for payments to be paid to a beneficiary or estate.

The above annuity factors can each influence how much you receive from your annuity. It may also differ between annuity providers. Annuity companies will base their calculations on these factors to assess the set amount that you will receive.

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At what age should you get a life annuity?

You are not expected to purchase your annuity at a specific age. Many financial advisors and insurance companies would advise you to purchase your annuity between the age of 55 and 65, with payments typically beginning between the age of 60 to 70. This hopefully will provide you with the maximum payments from your plan. Despite the recommended age it is ultimately your decision as to when the best time to invest in a life annuity.

Each type of annuity available presents their own benefits and drawbacks and you may find one specific type to be more suitable for your needs.

What are the benefits of a life annuity?

• A life annuity provides you with a secure income for the rest of your life eliminating any stress about having insufficient funds available to you once you retire. Your annuity will ensure that you receive a regular income payment according to the payment schedule agreed between yourself and your provider until you pass away.
• The money that is stored in your registered annuity isn't taxed until the funds are withdrawn. Typically, other retirement investments will incur an annual tax.
• With both the life annuity and term annuity, you have the option to leave any guaranteed payments to your beneficiaries or estate when you die.
• An annuity is a great way of supplementing your income when you reach retirement age and, depending on the plan that you choose, you will then be financially covered for the rest of your life.

What are the drawbacks of an annuity?

• Variable annuities can incur additional fees including administrative and mortality expenses.
• Opting for a term annuity may see you outlive the term agreed in your plan, which means that you may reach a point where you stop receiving payments while you are still alive.
• A variable annuity can see your payments fluctuate depending on how well your funds perform. One month you may receive a high payment if it has performed well. However, the following month you may receive a lower payment if it hasn't performed well. For some, this lack of stability in the payments that they receive makes it hard to predict your regular income.

Do I need a life annuity?

• Purchasing an annuity is not compulsory; it is simply a choice that is offered to you as you approach the age of retirement. Aside from making your money easier to manage, an annuity also ensures that you have access to a regular source of income when you retire.
• This is going to be essential for individuals who currently don't have an income and are solely reliant on this series of payments. While some individuals may choose to invest 100% of their pension into their annuity, others may choose to use a smaller amount, using the remaining amount as support payments when they retire.
• An annuity may not be necessary for all individuals. For those who have money invested in other pensions or savings that they can use, investing in an annuity may be less beneficial. It is important to assess your individual needs as you approach the period of retirement to evaluate your needs at this time. This can then aid your decisions as to whether an annuity is going to be beneficial to you.

Final Thoughts

Many insurance providers in Canada offer annuities that you can select depending on your needs. For some, they can be the perfect retirement option ensuring that you are provided with a regular income to live on once you have reached the point of retirement. They can also make it much easier to manage your money. Some may prefer to have their plan in place ready for the future and so a deferred annuity is going to be the best option to cater to their needs. It is crucial to ensure that you select the annuity that is suitable for your requirements. Ensuring that you are fully familiar with each of the terms outlined by different providers is important. While each type of annuity comes with its own benefits and drawbacks,you may find one to be more compatible with your needs than others.

Although an annuity may not be suitable for every individual, they have many benefits and provide social security for those that wouldn't have any guaranteed income without one. After paying into a pension, it can be beneficial to invest the proceeds into an annuity. While it isn't compulsory to invest your money from your pension into your annuity, it may be recommended by your advisors.

• Click Here To Find Out How Much An Annuity Will Cost