Life insurance is supposed to be collected by your heirs, right? There’s no way that you can collect the benefits of a life insurance policy, unless you do something either highly illegal or involving voodoo, correct?
Not necessarily. There is a life insurance product out there that can provide benefits to living insureds. This product is called an annuity, and life insurance customers are using it to provide themselves with income after they retire, or to minimize their tax burden.
In general, customers who buy an annuity purchase it with regular payments stretched over a number of years or all at once with a lump sum. Once the price of the annuity has been paid, the insurance company makes payments to the customer for the term of the annuity or until the annuity purchaser dies. Once the purchaser of the annuity dies, the payments cease.
An annuity is essentially a bet with an insurance company that you will die before the insurance company pays out the value of the money you paid them plus the income the company has been able to earn from investing your money.
There are various types of annuities, each with different features. Being able to identify the pros and cons of each type of annuity is important to being able to make an informed decision regarding this insurance product.
For example, an annuity that makes payments in set amounts or amounts that increase each year by a settle-upon percentage are known in the insurance industry as fixed annuities. In contrast, a variable annuity will pay changing amounts. These amounts depend upon the performance of investments that your insurer put your money into, such as bonds and mutual funds.
Many folks use variable annuities to put off paying taxable gains on investments. Any money you put into a variable annuity is considered a tax-deferred investment, meaning that you don’t get taxed until withdrawals are made from the account. Money managers like this because it means they can grow wealth without being socked with yearly taxes.
One of the drawbacks of an annuity is that if the person who bought the annuity dies before the payment period is up, all that money is lost. Also, if the annuitant outlives the payment period, payment also stops. There is a product that can get you around this, however. A guaranteed annuity will allow payments to continue if the annuitant outlives the payment period. Also, a guaranteed annuity will also continue to make payments throughout the payment period if the annuitant dies before the payment period is up. This type of policy costs more and makes smaller payments in exchange for the reduced risk of loss to the annuitant, however.
Married couples have in the past been stung by annuities, because the income they were both depending upon stopped with the death of the spouse who was the annuitant. Married couples who want to ensure that they continue to get payments from their annuity even if one spouse dies can purchase a joint annuity. In a joint annuity, payments will continue to the other spouse if one spouse dies. The payments don’t stop until the death of the second spouse. To reduce their exposure, some companies reduce payments to the second annuitant after the death of the first spouse.
A great advantage of an annuity as opposed to living off investments such as a 401 (k) plan is that with a guaranteed income annuity, you’ll always have a steady income to draw. If you just live off of earnings from your 401 (k) plan or an IRA, you run the risk of exhausting this money before you die. A growing number of retirees are choosing to cash out their 401 (k) plans when they retire and purchase an annuity in order to obtain this guaranteed income. Potential drawbacks of an annuity are high service costs and surrender fees.
As the Baby Boomer generation continues to age, it’s expected that annuities will grow in popularity as folks look for ways to fund their retirement. An annuity can be a good option, especially for higher income earners looking for a way to minimize their tax burden. As with any investment, it’s important to consult with your money manager or financial professional before purchasing an annuity. Trained professionals can walk you through the ins and outs of annuities and help you decide if it’s the best option for you to fund your retirement needs.