Annuity can be simply defined as a sum of money payable to a person over a specified period of time, generally for the rest of his/her life. Annuity is an investment product that aims at providing regular income to a person post-retirement. This is done by converting a sum of money or savings into the income for the coming years. Annuity products can be purchased from an insurance company.
§ How does annuity work?
The first step is to decide upon the amount that the client wishes to invest. The insurance company calculates the number of years for which the investment will provide an income for. Or it can be done the other way round. The client can specify the desired amount of income to be received over a period of time and the insurance company will calculate the amount that needs to be invested.The amount of income also depends upon other factors such as sex and age of the client and whether the benefits will be enjoyed by the client or his partner as well.The income may be payable to the client on a monthly, quarterly, half-yearly or yearly basis, as specified by the client.The income received per annum from the annuity on the amount invested is called as the ‘annuity rate’ expressed in term of percentage. For example, a client invests £200,000 and the annuity rate being offered is 5%, then the client will receive £10,000 as an annual income from the annuity.
The annuity rates quoted are different for men and women of a given age. The rates also vary for clients belonging different age groups. Generally higher rates are quoted men and for older clients.
§ Types of annuity?
The two most popular types of annuity are ‘fixed annuity’ and ‘variable annuity’.Fixed annuityAs the name suggests, this type of annuity pays out a fixed amount of income over a period of time. Fixed annuity involves low risk due to the fixed rate of return and guaranteed regular income. Annuity rate is determined considering the amount of investment and maturation period.Variable annuityVariable annuities are characterized by the variable rate of return, which depends upon the changes in the value of the underlying security. This attaches a higher level of risk to the variable annuities, since the returns fluctuate due to the volatility in the securities market. Variable annuities are suitable for the clients with higher amount of savings and higher risk appetite.§ Why buy an annuity?
Annuity is one of the most efficient tools of the retirement planning strategy. It aims at generating income from savings or pension fund. There is no upper limit on the amount to be invested into an annuity. This helps the client to invest large amount of funds into an annuity and no tax is imposed on such funds. Thus, annuity provides an additional income to the client. However, the income earned from annuity is subject to tax.
