When your clients approach retirement, they often face a common challenge: how to turn their savings into reliable income that will last as long as they live. Annuities offer one answer to this problem.
As an aspiring or currently working financial advisor, understanding annuities can help you better in providing guidance on whether this product fits your clients' retirement strategy. In this article, Wealth Professional Canada will explore what annuities are and what factors your clients should consider before investing in one.
An annuity is a financial product that provides your clients with a guaranteed regular income. Most people use annuities during retirement, and they're sold by annuity providers like life insurance companies. For financial advisors helping clients plan for their later years, annuities represent one option among many retirement income sources.
Your clients can purchase an annuity with a lump sum or through multiple payments over time. Once they've invested their money, they'll receive regular income payments. These payments come from a combination of interest and a return of their capital.
The third source is a transfer of capital from annuity holders who die earlier than statistically expected to those who live longer than expected. This structure explains why longer-living annuitants receive more total income from their initial investment. Watch this video to learn more:
Annuities function as a type of investment vehicle that converts lump sums or regular contributions into periodic payments, often with tax-deferred growth potential.
Insurance companies usually manage annuities by investing the underlying funds in bonds, stocks, and other securities to generate the returns that support those future payments.
Give your clients a better idea of how much annuities they could receive. Try our annuities calculator for free!
When your clients buy an annuity, they're essentially exchanging a lump sum of money for a stream of guaranteed income. This income stream continues for either a set period or for the remainder of their life, depending on the type of annuity they choose.
The income your clients receive isn't simply a return of their original investment divided into monthly installments. Instead, the monthly payment includes a portion that represents these three:
This pooling arrangement is unique to annuities. It means that when someone in the annuity pool dies earlier than statistically expected, the remaining payments they would have received get distributed to those who live longer.
This feature allows your clients to receive guaranteed payments regardless of how long they live.
The amount of regular income that clients receive from an annuity depends on several factors:
Your clients have flexibility in how they receive payments. They can choose to receive income at different frequencies, including monthly, every three months, every six months, or once a year. You might find that monthly payments work best for your clients because they align with regular household budgeting.
Clients also have options for when to start receiving payments. They can choose immediate annuities and begin receiving income right away. Alternatively, they might purchase a deferred annuity and start receiving payments at a later date.
Deferred annuities usually provide higher regular payments than immediate annuities because clients will receive fewer total payments during their lives.
Whether an annuity is better than a pension depends on your clients' situation. When your clients buy an annuity, it's like buying their own pension with a lump sum. Both products provide regular, guaranteed income that doesn't depend on market performance.
The difference is that pensions come from employers, while annuities are available to anyone with savings. This makes annuities especially valuable for your clients without a workplace pension. They appeal to DIY investors, conservative investors who want to avoid market volatility, and those with smaller savings.
Overall, your clients can create the pension-like income that many retirees enjoy through an annuity purchase.
Here's the primary disadvantage of annuities: your clients might not live to that age to recover their initial investment. With a life annuity, if your clients die before reaching the breakeven point, they lose the remaining portion of their capital.
Let's use a sample scenario. Suppose that Client A purchased a life annuity for $100,000 when she was 65 years old with $500 monthly payments. She'll be receiving $30,000 in total income by the age of 70.
If Client A dies at this point, she will only recover 30 percent of her investment. To break even and receive her full $100,000 back, she needs to live to age 82. If Client A lives past that age, she'll receive more than her original investment.
The risk that she might not live to that age is a genuine concern and a reason some of your clients might hesitate.
Your clients can choose from three main types of annuities, each with different characteristics and benefits:
A life annuity provides your clients with a guaranteed lifetime income. As long as your clients live, they receive their monthly payment. This addresses one of the primary concerns in retirement: outliving their savings. With a life annuity, your clients never have to worry about their money running out.
Life annuities offer several options that your clients might consider:
this allows income payments to continue as long as one of the annuitants is alive; it also works well for couples who want to guarantee ongoing income for the surviving spouse
this means that payments continue to be paid to a beneficiary or the estate if your clients die within a specific period
this provides a one-time payment to a beneficiary or the estate if your clients die before receiving a specific amount of money, usually what they paid for the annuity
Investors can combine these options, but each additional feature will lower the amount of their regular payment. This trade-off is important to discuss with your clients, so they understand what they're giving up for the protection they're gaining.
This type of annuity offers a guaranteed income for a fixed period. If your clients die before the end of the term, their beneficiary or estate will continue to receive regular payments. They might also get the regular payments' balance as a lump sum.
Let's use a sample computation. For a $100,000 investment, the monthly payment amounts vary based on the chosen term:
This structure reveals a vital principle: longer terms result in lower monthly payments, but higher total amounts received. Your clients must decide whether they prioritize higher monthly income or maximum total return.
A variable annuity is when the provider invests your clients' money in products with a variable return, such as equities. Your clients receive a fixed income portion and a variable income portion. The fixed income is usually lower than what they would earn with a non-variable annuity.
The variable income portion changes based on investment performance. If the investments perform well, your clients earn more money. If they perform poorly, your clients earn less. This introduces risk that non-variable annuities don't have, but it also offers the potential for higher returns.
Your clients can find the retirement income approach that best matches their priorities through these three annuity types. Curious to find out how to use annuities in a retirement income plan? Watch this:
Canadian life insurance companies must be members of Assuris, a consumer protection agency that protects policyholders if the annuity provider is unable to pay. The protection covers 100 percent of monthly payments up to $5,000 and 90 percent for monthly payments above $5,000.
For example, if your clients' regular annuity income is $3,500 per month, they'll continue to receive the full amount if their provider goes out of business. If their income is $6,500 monthly, they'll receive 90 percent, which is $5,850. This protection provides peace of mind for your clients.
Annuities offer your clients a reliable way to convert savings into guaranteed lifetime income. These investment vehicles work best for those who want predictable earnings. As for drawbacks such as potential loss of capital if they die early and reduced income with added options, they require honest discussion with your clients.
As such, always consider their health and longevity expectations. You should also look at your clients' other income sources and desire to leave money to beneficiaries. Compare options from multiple providers and explain how different types work before recommending annuities to them.
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