You have probably heard about this financial concept, but what are annuities? An annuity is a financial contractual product, sold by financial institutions, that is designed to receive and grow funds from an individual.

Then, on the annualization, it delivers a series of payments to the same individual at a later date. The period in which an annuity is being financed and the payments have not yet begun, is called the accumulation phase. On the other hand, once the payments are initiated, the contract is in the annualization phase.

Explaining the annuity

We can not remain in a mere definition of annuity, after all, the important thing is to understand the purpose of these. Annuities were designed to be a reliable means, capable of ensuring a constant flow of money for an individual during his or her retirement years. In turn, these alleviate the risk of longevity and fears that a subject may live longer than their assets.

Annuities can also convert a substantial lump sum into a stable flow of money, for example, in the case of winners of the lottery or millionaire lawsuits. Defined benefit pension plans and social security are two examples of life annuity annuities, which pay retirees a fixed amount of money until they die.

Type of Annuities

Annuities can be structured according to a series of details and determining factors, such as the time during which the annuity payments can be guaranteed. Annuities can be established in such a way that, on annualization, payments will continue to be made while the pensioner or his spouse (if there is benefit to the survivor) remain alive.

On the other hand, annuities can be structured to pay funds for a certain amount of time, regardless of how long the pensioner lives. Also, annuities can begin immediately after the deposit of a lump sum, or they can be organized as deferred benefits.

Generally, annuities are structured as fixed or variable. A fixed annuity provides the pensioner with regular and periodic payments. A variable annuity, on the contrary, allows the owner to receive larger cash flows if the investments of the annuity fund are doing well, and lower if they do not perform well. This gives the pensioner a less stable flow of money than in the case of fixed annuities, but allows the pensioner to benefit from the profits of his fund.

One criticism that is made to annuities is that they are illiquid. The deposits made in annuity contracts are usually blocked for a period of time, known as the "surrender period", where the pensioner incurs a penalty in the event that the money is touched. These surrender periods can last from 2 to more than 10 years, depending on the particular product. Termination fees (Surrender fees in English) can start at 10% or more, and the sanction usually decreases annually during the surrender period.

Although variable annuities may involve some market risk and the potential to lose capital, annuity contracts can be added a series of additions and functions, which allow them to act as hybrid of fixed-variable annuities. Contract owners can benefit from the potential for portfolio growth, while enjoying the protection of a guaranteed minimum retirement for life if it loses value.

Other supplements can be purchased, for example, to add death benefits to the contract or to accelerate payments when the pensioner is diagnosed with a terminal illness. Supplements are used at the cost of living to adjust the flow of annual money to inflation, based on changes in the CPI.

Annuities in finance: Who sells and buys annuities?


Who sells?

Insurance companies and investment companies are the two financial institutions that offer annuities. What do annuities mean for these institutions? In the case of insurance companies, annuities are a natural cover for their insurance. Life insurance is purchased to deal with the risk of mortality - that is, the risk of premature death. The insured pays an annual premium to the insurance company, which in turn will pay a lump sum after the death of the same.

If the insured dies prematurely, the insurer will pay the death benefit at a net loss for the company. Actuarial science allows these companies to assign a price to their insurance policies so that, on average, the buyers of them live long enough for the insurer to obtain benefits. Annuities, on the other hand, address the risk of longevity, that is, the risk that a person will live longer than their assets reach to cover. The risk to the issuer of the annuity is that the owner of the annuity live longer than expected in their initial investment. Issuers of annuities can avoid the risk of longevity by selling to buyers with a higher risk of premature death.

In many cases, the cash value within a permanent life insurance policy can be exchanged for an annuity product, without tax burden, through an exchange 1305.

Agents and brokers who sell annuities must have an insurance license issued by the state, as well as a securities license in the case of variable annuities. These brokers usually earn a commission, based on the notional or theoretical value of the annuity contract.

Who buys?

Annuities are an appropriate financial product for individuals seeking a stable and guaranteed retirement. Since the lump sum invested in the annuity is illiquid and subject to withdrawal fines, they are not recommended to young people or those who need liquidity. Annuity holders can not live longer than their income stream, which covers the longevity risk.

As long as the buyer understands that he or she is changing a liquid lump sum for a guaranteed flow of money, the product is appropriate. Some buyers expect to withdraw the annuity in the future to make a profit, however, this is not the intended use of the product.

Immediate annuities are usually purchased by people of any age who have received a large amount of money, and who prefer to exchange it for cash flows in the future. The curse of the lottery winner is that many times they do not take care of their prize and end up spending everything in a relatively short time.