4 Important Risks at Retirements Solved By Annuities

 

 

Once you retire, you may think that you are done with risk. You can’t lose your job anymore since you don’t work. You can’t lose your house as your mortgage is most probably paid off by now. Then, there is not much to fear… or this is what you believe.

 

Unfortunately, there are several risks a retiree must face. Most of them are related to financial matters and can be solved with a little planning. For example, annuities can answer many of your retirement concerns. There are four risk annuities can solve at retirement:

 annuities and retirement

#1 Outliving Your Assets – You Still Live But Your Bank Account Died

 

One of the biggest risks at retirement is to spend all your money and still be alive. 50 years ago, when one retired, he had roughly 5 to 10 years to live. Today, you can retire as early as 55 or 60 and live until… 90! A life annuity could solve this concern quite easily. Since a fixed annuity is a guarantee stream of income until your death, you don’t have to worry about spending too much in your early days of retirement. You are set to receive the same pension forever.

 

#2 Loss of Spouse – Where Do You Find The Money?

 

We all know that living as a couple help cutting down on expenses such as rent, utilities and transportation. Once your spouse passes away, you are left to assume all expenses by yourself. This could be a problem if you haven’t planned it already. With a joint life annuity, you have the possibility of receiving the same pension payment after the first beneficiary deceases. Therefore, your budget is the same before and after your spouse passes away.

 

#3 Healthcare Assistance – How to Afford Nurse at Home

 

With aging population come healthcare growing needs. Several retirees prefer to stay in their home and require the help of a nurse from time to time. This is a good way to postpone your entry in a retired home. However, such service requires a good pension to afford it. This is where annuities come into play. If you purchase a longevity annuity, you will start receiving payments about the same time you may require healthcare services. This type of annuity is some kind of guarantee you can afford a nurse at home for a while and enjoy your place as much as possible.

 

#4 Inflation – What Used to Cost a Dollar

 

Inflation is definitely well hidden behind other retirees concerns. A small rise of 2% of your cost of living seems meaningless at first. But this is what makes a big difference if you enjoy retirement for the next 20 years. What used to cost a dollar will eventually double and this is true for most goods you purchase. Variable annuities allow the investor to increase its payment overtime. Since the investment return depends on the investment in the sub-accounts, you have better chance to match the inflation rate and keep your power of purchase intact during retirement.

 

Confused? Curious? You are looking for answers about annuities? Contact a trusted adviser that will take the time to explain you various options offered to you.

Insured Annuity Annuity

The insured annuity, also called back-to-back annuity, is a combination of two products: a life insurance and a fixed annuity. This product has been created for investors who seek both revenues and a guarantee of capital to be left to their heirs.

 insured back-to-back annuity

Back to Back Annuities Structure

 

As previously mentioned, the back-to-back annuity is a simple combination of a life insurance covering the amount used to buy a fixed annuity.

 insured back-to-back annuity structure

The idea behind this structure is to provide income to the investor while he lives and still protect his assets to be given to his heirs upon his death. The fixed annuity provides a steady stream of income to the investor. This distribution is used as a pension and also pays for the life insurance premium. Therefore, the net amount received by the beneficiary is smaller than a simple fixed annuity payment, but the capital used to purchase the contract remains intact upon his death. This strategy is used when the investor wants to make sure to leave something behind to his spouse or his children.

 

Main Advantages

 

Tax Efficient

As any other fixed annuity distribution, the insured annuity provides tax efficient revenue to the investor. Part of the annuity payment is considered a return of capital and therefore is not taxed. If an investor purchase an annuity at the price of $100,000 in exchange of payment worth of $7,000 per year, only a portion of this amount will be shown on his tax report as taxable revenue.

 

Income + Capital  are Guaranteed

The main advantage of this strategy is definitely to assure both a stream of income and the capital used at death. This product is 100% guaranteed from one way to another as both payments and amount at the end of the contract (death) are known in advanced and secured by the Life Insurance Company.

 

Better Return than CD’s

In order to appreciate the back-to-back annuity to its full value, an investor must compare it to a certificate of deposits where he would receive the interest but not the capital until maturity. In this case, the maturity is the death of the investor. The combination of the annuity return minus the insurance premium cost is considered to be the net annuity payment. Usually, the net distribution is higher than a certificate of deposit yield if both contracts are taken at the right age. There is a sweat spot between the actuarial calculation to price both annuities and life insurance premiums between the age of 65 and 75. This is always a case by case analysis you must do prior to enter into such contract.

 

Main Disadvantages

 

The Money is Locked-in

Once the annuity is purchased and the life insurance premium paid, it is not possible to withdraw more than the annuity payment (unless it is specified in the contract which would incur additional costs). You can always stop paying the life insurance premium and keep the fixed annuity, but you will lose the capital guarantee at the same time. While it is a good product to secure a part of your income at retirement, it is also wise to not invest all your money in a locked-in product.

 

Inflation Risk

If you purchase a sample fixed annuity, the payment will remain the same throughout the contract. If you happen to live a longer life than expected, inflation will gradually erode the value of your distributions. Since the money is not invested in the stock market, there are no ways for you to increase this payment.

 

Don’t Buy it Too Young or Too old

As previously mentioned, there is a sweat spot where the calculation for the back-to-back annuity is advantageous for the investor. If you buy it too young, the annuity payment will not be high enough to net a payment better than a certificate of deposit’s yield. If you buy it too old, the insurance premium will become too important to be paid by the annuity payment. Then again, your net investment return will fail to compete against a CD yield.

 

Final Thoughts on Back to Back Annuities

 

Since you have the option of securing both your pension payment and your capital you want to give to your heirs, the back-to-back annuity could be a great solution for a part of your nest egg. Its lack of flexibility makes the product inadequate to become the one and only source of income at retirement. Having said that, it is definitely worth it to have a talk with your adviser to see which scenario is best for your situation.

 Who Sells Annuities

Term Certain Annuity

 

 

There are two types of what we call “fixed annuities”. The term “fixed” come from the payment of the annuity. Therefore, a fixed annuity is offering a fixed… payment. It is usually a monthly income stream that is paid during the time of the contract. This is where the two types of fixed annuities come: Life Annuity and Term Certain Annuity.

 term certain annuity

Life Annuity

 

The life annuity is paid to the beneficiary upon his death. Once the beneficiary passes away, the remaining part of the annuity is left to the Life Insurance Company. This is a good product for investors who are in good health and plan to live longer. For more information, we cover life annuities in this section.

 

Term Certain Annuity

 

The term certain annuity provides a steady stream of income to the beneficiary until the contract expires. Therefore, if an investor purchase a 10 year annuity at the age of 55 and die at the age of 58, the Life Insurance Company will keep the rest of the money.

 

***I’ve read on Canadian Insurance Company sites that some term certain annuities can pay a lump sum payment equal to the remaining benefit of the annuity to your beneficiary (similar to a life insurance clause).

 

Term Certain Contract Main Advantage

 

The main advantage of term certain annuity is its cost. Since the annuitant (the life insurance company) doesn’t have to pay you until you pass away, it will simply have to consider a conservative investment projection and pay you accordingly.

 

This could be a great product if you seek for a temporary stream of income and you are not looking to add any life insurance component to your contract (in order to guarantee your payment over time for example).

 

Main Disadvantage

 

Since there are no free lunches in finance, term certain annuities are cheap but not perfect. In fact, chances are that you will outlive the term of your annuity and be left with no money and no income stream after the maturity date.

 

Imagine a scenario where you purchase a 15 years term certain annuity at the age of 55 and blow your 70th anniversary candles? That’s right, you’ll be crying that you are still alive since you will not be receiving any more money from your contract.

 

When Should I Purchase a Term Certain Annuity?

 

A term certain annuity is a good product if you only need income for a specific period (to cover your most active period of your retirement for example) or if you can’t afford to pay for a better contract (with insurance or additional return included).

 

Since I’ve found term certain contracts offering the remaining benefits in the event the investor decease prematurely, I suggest you speak with an adviser to know which contract is good in your state/province.

 

If you have any questions about term certain annuities, you can speak with a trusted adviser for free here.

Fixed Annuity

The fixed annuity (also called a life annuity) contract is the most common type of annuity. The main purpose of this contract is to provide a lifelong income stream to the investor. The investor invests a lump sum of money in exchange of a set of periodic payments (mostly monthly) until the moment of his death.

 life annuity

Example of a Fixed Annuity

 

Mr. Rogers is about to retire. His house is paid and he has some savings aside to insure a great retirement. However, he doesn’t want to see his portfolio value going up and down all the time. He remembers clearly what happen in 2008 and certainly doesn’t want to feel unease at retirement. His investment currently shows $500,000. He decides to take off $250,000 from his investment and buy a life annuity.

 

The life annuity is purchased from a Life Insurance Company and the periodic payments are fully guaranteed. The company agrees to pay Mr. Rogers the sum of $17,500 per year, the equivalent to 7% of his $250,000. The amount of the payment was based on the age and overall health condition of Mr. Roger. In other word, the Life Insurance Company doesn’t expect M. Roger to live for another 40 years (which would equal to a sum of payments of $700,000).

 

Calculation of the Investment Return

 

The investment return on a life annuity is unknown as it all depends on the date of death of the beneficiary, Mr. Rogers. For example, if the investor were to die three years after purchasing his annuity, he would have received a total payment of $52,500 from an investment of $250,000. Please note that on a regular life annuity contract, the remaining of the investment stays with the Life Insurance Company. Therefore, the estate of Mr. Rogers would lose $197,500. This is definitely not a good investment return!

 

On the other side, if Mr. Rogers beat the odds and live for 30 years, he would receive the sum of $525,000. This is a total investment return of 110% or a 5.65% annualized return. If you were to invest money today for 30 years, it would be impossible for you to find an investment paying a guaranteed 5.65%. This is why the life annuity could be a very interesting option for retirees.

 

Main Flaw of the Life Annuity

 

The main flaw of the life annuity is that the capital used to buy the contract is not guaranteed. This is why is it very important to make sure you don’t invest all your money into a life annuity and that you have a great life expectation (no family record, good health, healthy habits, etc).

 

If you pass away like Mr. Rogers three years only after buying a life annuity, you will be wasting a lot of money. While included in a financial planning approach, it is common to find a life insurance combined with the life annuity in order to protect the capital in such situation. This is called a guaranteed life annuity.

 

You still have unanswered questions? Speak to an advisor for free now.

 

Annuities & Retirement How to Retire Without Worries

lonWill I have enough money to retire?

 

This is a question that most people are asking themselves. It gets even more crucial questions as you turn 50 and you see retirement coming forward. Governments won’t be the most generous around with their social pension plans, your employer is probably not under any guarantee to pay a fixed pension and your savings… well you simply hope to not retire before the next crisis.

 

But what if you could enter in a contract guaranteeing you that you will get paid each month? No more worries, no more uncertainty, just a sustainable income stream for your retirement. Annuities could be a great solution for your retirement plan by providing you several advantages. Here’s a list of a few reasons why annuities and retirement go well together:

 

You Can Start Investing in an Annuity Today and Retire Later

 

One of the most unknown advantages of an annuity is the fact you can buy an annuity now and start saving money inside the contract. This is called a deferred annuity plan. You are basically building up your annuity while you still earn a pay check in exchange of a pension like payment at retirement. The interest rate paid by the annuity could be fixed (linked to certificate of deposits and bonds investments) or could be variable (linked to the stock market performance). You are not only building your own secured pension plan with an annuity but you also defer taxes on potential gains realized inside the annuity.

 

An Annuity Helps You Budget at Retirement

 

A common mistake with young retirees is to start spending money like they never did. You might be sitting on $500,000 or more in your retirement account (like a 401(k) or a 403(b)), but it could melt faster than you think if you don’t budget properly. A new car and a few oversea trips later and your $500,000 nest egg could drop to $400,000 within a few years.

 

After the purchase of an annuity, you will receive a steady payment on a monthly basis. Therefore, you will have to budget your retirement needs according to your annuity payment. This is a great way to ensure you don’t fall short after a few years of crazy spending!

 

The Annuity Insure You Against the Longevity Risk

 

Do you know one of the most important risks for retirees is to outlive their savings? 50 years ago, a retiree could budget until he is 75 and would not risk to lack of money before his death. Today, it’s not rare to encounter retirees who are 85, 88 and even over 90! My two grandmothers are still living and they are 90 and 92! If they would have bought an annuity at the age of 60, they could have spent a lot more at retirement.

 

The Life insurance company pays you according to your chances of being or not being alive in the next 10, 20, 30 years. Since they insure a lot of individuals, they calculate their break even point (and their profitable point) where they pay more for a few people who live over 85 and cash the money from the annuity from those who decease earlier.

 

The Annuity is a Great Tax Management Tool

 

If you need to withdraw money from any type of pension account, you are deemed to pay an important amount of taxes to the government. Nobody wants to retire and owes money in taxes! As your income is more limited, tax planning becomes crucial.

 

The annuity payment allows the investors to spread its tax bills across his entire retirement instead of paying taxes on lump sum withdrawals. If you purchase an annuity with cash coming from your bank account, you will also benefit from a tax advantage since part of the annuity payment will be considered as a return of capital and won’t be taxable.

A Retirement Plan Should Analyze Annuities

 

If you go see your financial advisor for a retirement plan, he should definitely analyze the possibility of adding an annuity or a combination of annuities to meet your retirement needs. There are several uncertainties around retirement and annuities are part of the tools to reduce your worries at retirement.

 

If nobody told you about annuities, you should speak about it with an advisor for free now.