Go Back

Annuity Intro 1
Purpose and function of annuities

Continue

Purpose and function of annuities

MR. WATSON: An annuity is really just a bucket of cash, like a giant savings account. The person who owns the annuity is called the annuitant, and generally the money is meant for that person, for the annuitant.  Traditionally, people use the money to help fund their retirement, but it doesn’t have to be used for that. So let’s start with some basics. The annuity can be used in one of two ways:

  1. As a tax deferred savings account, or
  2. As a vehicle that pays the annuitant a steady stream of income for life

MR. WATSON: Most of our discussion will be centered around the second method, using the annuity to pay a steady stream of income.

Life insurance protects those I love in case I die too soon. Annuities protect me if I live too long. It's the opposite side of the coin of a life insurance policy. An annuity takes a sum of money and pays it with interest over a person's lifetime. Put simply, you're trading a bucket of cash for a life-time stream of income.

 

Vocabulary: Know these! You will need to know the differences.


MR. WATSON: Anybody can provide an annuity; by knowing:

  1. The principal (the amount you put into the annuity),
  2. The assumed rate of interest it’s earning, and
  3. The length of the payout period (how many years it will pay you once you annuitize).

MR. WATSON: One important element, absent from this simple definition of an annuity, one distinguishing factor that separates life companies from all other financial institutions-anybody can set up an annuity and pay income for a stated period of time. Only life insurance companies can do so and guarantee it for the life of an annuitant.

MR. WATSON: Why? Because of life expectancy tables. Banks don't have mortality tables, so they use insurance companies' annuities. Yeah?

ALL: Yes.

MR. WATSON: An annuity is a "glorified" savings account in that any and all money deposited earns interest and that interest grows tax deferred. You pay taxes only on the interest when it is taken out.


Annuities versus life insurance

MR. WATSON: The principal function of a life insurance contract is to create an estate, by the periodic payment of money into the contract. The annuity's principal function is to liquidate an estate by the periodic payment of money out of the contract. Life insurance is concerned with how soon one will die. Annuities are concerned with how long one will live.

MR. WATSON: Annuity basics

MR. WATSON: Structure and design of annuities

Go Back
Go to:
Continue