A life annuity is considered as an investment and savings tool, especially directed towards families and the stimulation of the maintenance of the standard of living or well-being in the long term. It works like insurance that is activated when the individual gets old and stops working.
Typically, this type of financial investment product is offered by an insurance company or a credit institution and associated with a certain level of interest rate agreed at the signing between both parties. In life annuities, the longevity risk is covered by the entity providing the service, for example, an insurance company. This institution will incur higher costs if the pensioner lives for many years.
On the other hand, stopping a plan of this type and withdrawing the capital deposited ahead of time usually entails the payment of compensation or the recovery of less than the amount invested. So the entities that offer the product anticipate withdrawals of funds than expected.
This concept is often identified with investment funds or private retirement plans.
On the contrary, non-life annuities have a validity period that can end before the death of the insured.
Operation of the life annuity
During a certain period, a person undertakes to deliver or pay a periodic premium or fee to the entity or company with which the product is contracted. In this way, it accumulates for years an amount of money deposited and under a fixed or variable interest rate (which is the most frequent modality).
When the time comes, this amount will be collected through monthly income as a salary until the time of the owner’s death, in a very similar way to retirement pensions.
The capital transferred when opting for annuity insurance can also be deposited in one (known as a single premium) or several large payments, such as a bank deposit.
Advantages of a life annuity
- Help families. Especially in periods of economic crisis, people have the possibility of maintaining a level of income if they have previously decided to own a similar product.
- Eliminate longevity risk. Unlike annuities with a certain maturity, life annuities allow you to receive that income throughout your life, regardless of whether you live many more years than expected.
- Commonly this type of life annuity plan is single-person, although there is the possibility that they are for two people, frequently in the case of life insurance for couples or marriages who decide to share them.
- They are usually easily modifiable or adaptable in terms of the initial fee and the income to be received periodically.
- This type of income entails significant tax advantages for its owner.
Disadvantages of a life annuity
- This type of product is usually linked to higher initial costs, largely as they are long-term plans. That is why its bidders seek to obtain higher profits at the initial moment.
- As a savings tool that they are, life annuities mean that families dedicate fewer resources to consumption and, therefore, there is less movement of money in the economy.
- Generally, the costs associated with withdrawing funds before the agreed date are high, discouraging holders from interrupting these plans.
- In periods of economic instability, there is often mistrust towards the entities responsible for managing this type of financial product, while a certain lack of transparency is blamed on them in situations of economic problems.
Life annuity as a supplement
The life annuity can be acquired in a private institution to complement a pension already received by the State.
On the other hand, in some countries, there are Pension Fund Administrators (AFP), private entities where workers can save for their old age. These institutions allow people to transfer their funds to an insurance company upon retirement. If they do decide, they have the option of accessing a periodic remuneration for life
If the worker does not contract with an insurer, the AFP maintains custody of the capital saved and is responsible for paying a non-life annuity to the retiree. In this case, it should be noted that the contribution account is individual, that is, each person has a fund that can be depleted.
Additional clauses for annuities
There are additional clauses compatible with a life annuity contract. For example, it is possible to assign a beneficiary in the event of death.
Also, a guaranteed period can be purchased for an additional amount. So, if the pensioner dies, for example, during the first ten years of the policy, the beneficiary will receive the same monthly amount as the contract holder.
At the end of the guaranteed period, the beneficiary begins to receive the percentages according to the law, if applicable, as a monthly payment. In the case of the spouse, for example, it is usually around 50% of the contracting party’s pension.