Annuity is an investment product that aims not only at providing a stream of regular income to you post-retirement but is also a safe and tax-deferred. There are various types of annuities packed with different set of features and benefits. You must choose an annuity that will match your requirements and help you achieve your objectives of investment.
§ How does annuity work?
The working of annuity is very simple. You have a chunk of savings that you can invest in the annuity. The rate of return is called as the ‘annuity rate’ and it is generally higher than that of a company deposits. The annuity rate is expressed in terms of percentage. For example, you invest £100,000 and the annuity rate being offered is 8%, then you will receive £8,000 as an annual income from the annuity.
You may decide upon the amount that you wish to invest in an annuity. The insurance company then calculates the period for which the investment will provide payouts for. Alternatively, you can specify the amount that you wish to receive in the form of regular payouts over a period of time and the insurance company will calculate the amount that needs to be invested.The amount of payout is determined by factors such as your gender and age and whether the benefits will be enjoyed by you or your partner as well.The withdrawals may be made on monthly, quarterly, half-yearly or yearly basis, as per your requirement.
Different annuity rates are quoted for men and women of a given age. Generally annuity rates are higher for men and for older clients; and lower for women and younger clients.
§ Types of annuity
1. Fixed annuity
Fixed annuity is an investment product that is similar to the Company Deposits (CD). It pays out a guaranteed rate of return (the annuity rate) which is generally higher than the bank CDs. This type annuity is characterized by a substantially lower amount risk because it provides guaranteed income. Annuity rate is fixed on the basis of size of investment and duration of maturity period.
The biggest advantage offered by this annuity product is that it allows you to invest more money, because it doesn't prescribe an upper limit.When you decide to cash out the annuity you may withdraw the lump sum amount or may opt for guaranteed regular payouts for a specific period or lifetime.A fixed annuity may be immediate or deferred. These types are discussed further on.2. Variable annuityThe variable rate of return is a major distinguishing feature of variable annuity. This rate depends upon the value of the underlying security or asset at a given time. A higher level of risk is associated to the variable annuities, since the returns fluctuate with the fluctuations in the securities market. Variable annuity is suitable for you if you have substantial amount of funds, a part of which can be invested in this type of annuity. You must also have a higher risk appetite. If you have already retired or are approaching retirement age it is not advisable to you to invest funds in such a risky product.3. Indexed annuityIndexed annuity is also known as hybrid annuity. Hybrid annuity is a combination of both, the fixed annuity and the variable annuity. It possesses the features and benefits of both the types of annuities. It has the element of safety offered by the fixed component, and the growth potential offered by the variable factor. The funds are invested in the fixed and variable components at the same time. Most of the time indexed annuity is principle protected. You get a guaranteed return from the fixed component. When the security market rises the gains are credited to your account. When the security market falls the loss is not supposed to be borne by you. Thus, you get the best of both worlds. This type of annuity also includes death benefit which would be payable to the beneficiaries or your heirs in case of event of your demise.4. Longevity annuityLongevity annuity is the exact opposite of term annuity. Term annuity provides payout only for a specific number of years. Longevity annuity provides you the protection against the risk of outliving your funds. Once you start receiving withdrawals, longevity annuity guarantees that you receive the regular payouts for the rest of your life.This type of annuity requires you to attain 80 years of age before starting to cash out the annuity. Therefore it is also called as advanced life delayed annuity. It is advised to invest a small portion into longevity annuity, say 10% to 20%, and invest the remaining amount in another retirement accounts.The later you choose to cash out, the larger your payments will be. There is one drawback attached to longevity annuity. In the event of your demise before any payouts have been received your heirs will not get anything.5. Deferred annuityWhen you invest your funds in a deferred annuity the funds stay invested with the insurance company for a specific period of time, before you start receiving the payouts. This period of time is known as maturity period. Higher rates are offered on annuities with a longer maturity period. Deferred annuity is best suited to you if you do not require funds in the short run. A deferred annuity may be fixed or variable.6. Immediate annuityImmediate annuity works exactly opposite of the deferred annuity. There is no maturity period in case of immediate annuity. You start receiving payouts as soon as the lump sum is invested with the insurance company. The rates offered are lower than those on the deferred annuity. Investment in immediate annuity generally invites higher charges from the insurance company and substantial taxes due to early withdrawal. An immediate annuity may be a fixed annuity or a variable annuity.Annuity proves to be an effective tool for planning your retirement if chosen carefully by analyzing your financial position, risk appetite and the long term objectives. Try to match these with what different annuities have to offer. Choose a type that meets most of your needs.