What is an Income Annuity?

What is an Income Annuity?

Income annuities are used by people in retirement to give them a steady, dependable stream of income until they die.

It is a financial product sold by a life insurance company, which serves as a kind of longevity insurance, so that people cannot outlive their money. People often roll lump sums from 401(k)s into these plans. Though inflexible, the income payout rate is designed to be appealing when compared to most retirement investments.

Life insurance is designed to hedge the financial risk to a family of one of their family members dying early. Income annuities are designed to hedge the financial risk of living too long. There are other kinds of annuities, but income annuities are perhaps the simplest.

A person takes a sum of money, or perhaps save it up inside of a type of income annuity, and at some point around retirement age the person will choose to commence the income payments from the annuity. Once they are begun, they generally cannot be stopped or modified.

These products have historically been very rigid but some companies are now making tweaks and hybrid-type annuities that blend features of income annuities and other kinds, such as indexed or variable annuities. For an income annuity, the company will have a stated rate of annual payout based on the amount to be annuitized (turned into an annuity income stream) and the age of the person(s).

They use actuaries and mortality tables (found here) to determine the amount of annual or monthly payments that can be made to an annuitant based on their age and life expectancy. 50% of the annuitants will die before the average life expectancy, and 50% of the annuitants will die beyond their life expectancy.

The ones who die before may still have a remaining principal balance left which will be paid to beneficiaries. The ones who die after will benefit from what’s called a mortality pool, which is the pooled money and interest that is available to pay the annuitant income where their own money would have likely failed.

It is generally not advisable to tie up more than 50% of a person’s retirement assets in an income annuity, because they would give up liquidity and access to the more than the income stream allows for. People often become joint annuitants with their spouse to ensure that the money will last as long as either of them is alive.

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