When entering retirement, many people have the option of using their retirement savings to purchase an annuity. An annuity is a contract purchased from an insurance company. The advertisements suggest that if we purchase an annuity, we will have a guaranteed pension for the rest of our lives. An annuity is simple and straightforward but is it the best option?
Advantages of Annuities
- A lump sum is used to purchase an annuity and life has been simplified. There are no more ongoing investment decisions and the purchaser has obtained a level of certainty concerning the level of future income
- In certain jurisdictions, annuity payments may be protected should the recipient become bankrupt.
- In certain circumstances, there may be tax deferral advantages of an annuity, but this varies significantly between jurisdictions.
- The size of the annuity is dependent upon the rate of interest when the annuity is purchased. Since we have been in a period of low-interest rates, annuity values are quite low by historical standards
- If a life annuity is purchased, the payments stop when the purchaser dies. Assume a 65-year-old man paid $100,000 to purchase an annuity. It would pay approximately $500 per month. The amount would vary by the age and gender of the purchaser. If the payments were received on the last day of the month, a person who purchased an annuity of July 1, 2017, but died on August 15, 2017, would receive a payment of $500 on July 31 and the insurance company would make no further payments
- The fees related to annuity purchases tend to be hidden, so it is prudent to inquire. Annuities charge amount the highest fees of any investment.
Managing Annuity Purchases
Consider the following steps to better utilize the annuity purchases:
- There are normally options that will provide protection in case of premature death. For example, there could be a guarantee period or the annuity could contain a joint survivor option. Any option that is selected will reduce the amount of the monthly income.
- Annuity payments can vary significantly between issuing companies. Shop the market and get quotes from various firms.
- When an individual purchases an annuity, there is assumption the issuer will stay in business in the foreseeable future. Determine if there is government protection for annuity payments in case of insolvency in your jurisdiction. It is not easy to assess the financial health of the company that issues an annuity but do not assume the company will be in existence for the rest of your life.
One of the disadvantages of writing to an audience that lives in various countries is that the tax rules vary significantly. You should discuss the specifics of your circumstances with a financial planning or tax expert in your jurisdiction.