Purpose & Function
MR. WATSON: Annuities are designed to pay out a steady stream of income for a lifetime, no matter how long that life lasts.
Annuity Basics
MR. WATSON: Take a sum of money - $12,000, the principal. Pay it out over an expected period of time -- 12 months, the life expectancy, derived from the mortality table (I am just making up numbers). Pay it out over a 12-month period, at an interest rate. Let's say 0%, for simplicity's sake. How much are you going to get?
STUDENT: A $1000 a month until you die, no matter how long you live.
MR. WATSON: How did I get the 12 months? From a mortality table. Do you remember? (A mortality table tells us two things, life expectancy & number of deaths at a given age) That's all an annuity is.
STUDENTS: A $1000 per month. And that is just a made up number for illustration purposes.
MR. WATSON: Yep. That's an annuity. You are buying income. The more money you have in the "bucket" the more monthly income it will pay you. Let's talk about how the money got in the bucket, how you put it in the bucket. You invest either a
- lump sum or
- periodic payments (monthly, quarterly, etc).
MR. WATSON: That's basically it. Going back to the example above, let's talk about what happens if I die before that 12th month, and what happens if I live beyond it. Once you annuitize, (begin taking payments) you can't stop it.
Structure & Design including the Funding Methods (see above chart)
- Funding Method
- Date annuity benefit payments begin
- Investment configuration
- Payout period
MR. WATSON: How did that money get into this annuity? This is an annuity (pointing to a water cooler).
MR. WATSON: So, I invested money in that annuity. I just started putting money in. Any amount, unlimited amounts. Anytime I want. After-tax dollars, dollars that had already been taxed. That money is invested, and it earns interest and it grows, and I don't pay taxes on that money, the interest, while it grows. This is called the "accumulation period." The taxes are deferred. Do you understand? I don't pay taxes on it while it grows. If I had a savings account at the bank, each year the interest would be taxed.
MR. WATSON: There are two ways to get money in
- lump sum or
- periodic payments.
Lump sum just means I throw money in and I walk away. Periodic payments means I put money in on a monthly, quarterly, semi-annual, basis. It can be fixed, $100 a month, or flexible, $100 this month, next month 50 bucks. It can't lapse. There's no insurance. The insurance company will never ask you any health questions, so you don’t have to be insurable. It's just a bucket of money. So how does the money get into an annuity? With a lump sum or periodic payments.
MR. WATSON: The money is invested and it earns interest. Do I pay taxes on it while it's growing?
STUDENTS: No, that's why they call it a "tax-deferred" annuity.
MR. WATSON: That's the beautiful thing about it while it's growing, the taxes are deferred.
MR. WATSON: There are two periods with an annuity.
- The accumulation period and
- the annuity period.
What does "accumulate" mean? Accumulate, it's growing, earning interest.
MR. WATSON: You are either in the accumulation period or you are in the annuity period. Annuitize means I am taking a steady stream of income from the annuity.
MR. WATSON: What's the annuity period mean? The annuity period is when you are taking a steady stream of money out of the annuity. You trade your bucket of money for a lifetime of income. You can do this at any age, and we will talk about this in detail shortly.
