By David Hanzlik
401(k)s, Roth IRAs and annuities are all great strategies to help families plan for their future in retirement, and each comes with distinct benefits. While the current low-interest rate environment may make some of these strategies less appealing, income annuities remain a notable option.
Income annuities deliver payments at regular intervals which are set when contracts are issued and can never decrease, even during times of economic volatility. For many people, knowing their income will remain steady even during the most catastrophic market crash is reason alone to invest in an income annuity.
This type of peace of mind and financial certainty could be even more valuable in light of the COVID-19 crisis – a recent CUNA Mutual Group Survey of Pandemic Financial Stability, conducted on 1,000 U.S. adults ages 18 or older and making an annual income between $35,000 and $99,999, found that 30% of respondents said that the pandemic decreased their financial stability. Other potential advantages of income annuities include helping clients manage longevity risk – the risk of outliving one’s assets – and providing death benefits that create a legacy for loves ones.
But there isn’t just one type of an income annuity…
- The simplest form is a “life only” income annuity, which has no death benefit. Income payments are paid as long as the annuitant is living and stop when the annuitant dies.
- A “life with cash refund” income annuity makes payments the same way, but if the annuitant dies before the total of the payments made equals the principal invested in the contract, the difference will be paid to a beneficiary. This option ensures the premium is always returned.
- A third option, “life with guarantee period,” means that if a person dies before a designated number of years, his or her beneficiary receives payment until the end of the period.
- And finally, a fourth option, “installment” makes payments for a designated number of years, but there is no lifetime income guarantee.
Annuities that offer lifetime income guarantees – all types other than “installment” – are partially paid for by mortality credits. Since some people will live longer than their life expectancy – based on mortality tables – while other will live shorter, those who live shorter than their life expectancy help fund those who live longer. This funding – or gains paid to those who live longer – is known as mortality credits. Mortality credits are a way of pooling risk among participants to generate higher guaranteed income. Mortality credits allow for a guaranteed source of income that is much more cost-effective during the current low-rate environment.
This is where a tradeoff is made – the more guaranteed payments, the lower the mortality credits and, therefore, the lower the income payment. The advantage of the “life only” option is receiving the highest possible income, but the disadvantage is there will be no financial legacy paid to beneficiaries. Conversely, the “life with cash refund” and “life with guarantee period” options will have lower income payments but could provide a financial legacy to beneficiaries if the annuitant dies earlier than expected.
By using an income annuity to manage longevity risk and meet basic income needs, remaining assets are available to be used for other purposes – like “wants” or unforeseen expenses – without jeopardizing those basic income needs. Ultimately, each individual and their financial advisor needs to evaluate how well different portfolios perform at meeting basic income needs, generating liquidity for other needs or wants, and creating a financial legacy for loved ones.
About the author: David Hanzlik
Dave Hanzlik is vice president of Annuity & Retirement Solutions at CUNA Mutual Group, a leading insurance, financial services and technology company focused on helping people achieve financial security through all life stages.
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