2 minute read


What Is An Annuity?

An annuity is a contract sold by a life insurance company that guarantees a stream of payments to the buyer (the annuitant) that begin at a specified time, often at retirement. With an annuity, the annuitant is literally buying a future income. There are different types of annuities. Deferred annuities are purchased either with a single payment or by regular premiums during the annuitant's working life with the specification that the funds are to be used at some future date. Immediate life annuities are bought at the time of retirement—the purchaser makes a single payment to an insurance company, which invests the money and begins to send the annuitant regular payments immediately.

Annuities provide a regular income that cannot be outlived. Monthly, semiannual, or annual payments are made until the annuitant dies. Therefore, an annuity provides a form of security that investments in stocks or bonds can't. Some annuities also name another person, such as a spouse, to continue getting income payments after the annuitant dies.

An annuity can be either fixed or variable. A fixed annuity has payments that are specified in the contract and usually remain the same, while a variable annuity has payments that go up and down based on underlying investments in the stock market or other securities.

There are also special kinds of annuities that are sold by charitable organizations that let an annuitant withdraw money in a lump sum. These annuities pay income only for a limited time.

Unfortunately, there is no magic formula for determining how much income is needed after retirement. Most financial planners agree that to maintain the same standard of living after retirement as before, an individual will need an annual income that is roughly 70 percent of his or her gross income before taxes while working. But this is only a rough estimate. Each person needs to refine it for his or her own situation.

Table 1 Purchasing power of a fixed $10,000 income. SOURCE: Actuarial Foundation, 2000

Nor is it possible to know how long a person will need a retirement income. Life expectancy figures exist, but while they are useful for calculating what will happen with large numbers of people, they don't help in calculating how long an individual will live. Actuaries say longevity is a "moving target." For example, an actuarial table might indicate that people 65 years old can expect to live another twenty years, or to age 85. However, of that group, those who live to 75 can then expect to live to age 87.5; and those who live to 85 can expect to live to 91.5. And, since women tend to live longer than men, 65-year-old women are 8 percent more likely than 65-year-old men to reach age 80, and 81 percent more likely to reach age 90. Because this is true, married women usually survive their spouses, often with much less income than before.

Additional topics

Medicine EncyclopediaAging Healthy - Part 1Annuities - What Is An Annuity?, How Does Inflation Affect Retirees?, Why Buy An Annuity?, Alternatives To Annuities