One of the best ways a person can prepare for retirement is with a life insurance annuity.
Properly structured, this one investment tool can provide the buyer with a guaranteed income for life without any need for further action or effort. Read also: Top Five Benefits to a Life Insurance Trust.
What is an Annuity?
An annuity is a financial contract that, in exchange for a specific amount of money, promises to pay the buyer a series of regular payments in the future. It is typically purchased from a life insurance company or other financial institution.
Types of Annuities
- Joint Life or Joint-Survivor
- Impaired Life
- Equity Indexed
- Return of Proceeds
- Single Payment
When considering adding a life annuity to your investment portfolio, there are several questions that need to be answered.
- How do you plan to pay for it? Lump sum or payments?
- When do you want it to start paying you? Now or later?
- How long do you want the payments to continue?
- What if you die before your money has been returned?
- What about your spouse?
- What if you contract a terminal illness?
How you answer those questions will determine what type of annuity will fit your needs. Read also: Getting Quality Life Insurance Quotes in the USA.
Paying for it
If you have reached retirement age and want to convert your IRA or 401K to a life income, you can purchase a single payment annuity. You make one large payment and begin immediately to receive a series of payments in return. This is also an option for someone who has received a lump sum settlement, such as a lawsuit award or insurance settlement.
If you have years ahead of you before retirement, you can purchase an annuity in installments. You simply contract to pay in a specified amount of money periodically over a number of years. That period is called the accumulation phase. When you reach retirement, the distribution phase begins.
How your money will be invested for growth
At the time you purchase your life insurance annuity, you will be asked to choose how you want the money you are paying into your annuity invested. One choice is a guaranteed, fixed rate of return. The other is a rate that varies, depending upon the actions of the investment vehicle you choose. Typical investment options are stocks or mutual funds. Read also: Who Can Benefit From Term Life Insurance?
Each choice has its benefits and its drawbacks. With the fixed annuity, you have a guarantee. You know how much money your investment will earn. However, because it is guaranteed, it won’t earn as high of a rate as you could possibly earn elsewhere.
With the variable annuity, you can take advantage of the stock market when it is strong. This can increase the value of your annuity much faster that the fixed rate. The drawback is that you can also lose value in your annuity if your investment choices do poorly.
There is a third choice available. Equity indexed annuities are a combination of a fixed and a variable annuity. Typically they use a stock market index, such as the Russell 2000 or the S&P 500 to determine your rate of return. Read also: Life Insurance Options for Diabetics.
The Distribution Phase
Prior to the onset of the distribution phase, you must choose how you wish to receive your payments. There are nearly as many options for distribution as there were for investments during the accumulation phase.
If you choose a straight annuity, you will receive a specific amount on a regular basis, such as monthly, quarterly or annually for as long as you live. When you die, any money remaining in the annuity is forfeited.
If you fear that you will die before you receive everything you have put in, you can choose the option called “Guaranteed Return of Proceeds.” This way, if you die early, your estate will receive the remainder of the money in the annuity.
A married couple may choose the option of Joint-Life or Joint-Survivor distribution. This option is structured to deliver payments until the death of the second spouse. Read also: Comparing Life Insurance While Getting Older.
In the event of a medical diagnosis, which reduces life expectancy, it is possible to qualify for a change in the distribution terms of the annuity, allowing you to receive higher payments. This is called an Impaired Life Annuity.
A life insurance annuity should be considered longevity insurance. It removes the fear and uncertainty of wondering if you will outlive your income by ensuring that you will have a guaranteed income for life.