What is an annuity?
An annuity is a contract that’s issued and distributed by an insurance company and bought by individuals. The insurance company pays out a fixed or variable income stream to the purchaser beginning right away or at some time in the future in exchange for premiums they’ve paid. It’s not the same as a life insurance policy that only pays benefits when the insured dies.
(Investopedia)
How can I use an annuity?
Annuities are designed to provide a steady cash flow for people during their retirement years to alleviate the fear of outliving their assets. These assets may not be enough to sustain their standard of living, however, so some investors may turn to an insurance company or other financial institution to purchase an annuity contract.
These financial products are appropriate for investors, known as annuitants, who want stable, guaranteed retirement income. Invested cash is illiquid and subject to withdrawal penalties so it’s generally not recommended that younger individuals or those with liquidity needs use this financial product.
(Investopedia)
Annuity vs. Life Insurance.
Life Insurance
Life insurance companies and investment companies are the two primary types of financial institutions that offer annuity products.
Annuities are a natural hedge for their insurance products for life insurance companies. Life insurance is bought to deal with mortality risk or the risk of dying prematurely. Policyholders pay an annual premium to the insurance company that will pay out a lump sum upon their deaths.
The insurer pays out the death benefit at a net loss to the company if the policyholder dies prematurely. Actuarial science and claims experience allow these insurance companies to price their policies so insurance purchasers will live long enough on average to allow the insurer to earn a profit.
The cash value inside permanent life insurance policies can be exchanged for an annuity product via a 1035 exchange without any tax implications in many cases.
Annuities
Annuities deal with longevity risk, or the risk of outliving one’s assets. The risk to the issuer of the annuity is that holders will survive to outlive their initial investment. Annuity issuers may hedge longevity risk by selling annuities to customers with a higher risk of premature death.
(Investopedia)
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