Your odds of picking the winning numbers and thus winning millions of dollars in the lottery are infinitely small. It is highly unlikely that you will open your front door and be told that you are the winner of the Publishers Clearing House sweepstakes. But, if you do happen to win a huge cash prize, chances are you will have the choice of receiving either a lump sum or taking a series of annual payments that might stretch 20 years into the future.
Receiving a series of future payments on a lump sum of money today is the basic definition of an annuity. Annuities come in many forms and may be an appropriate way to create a guaranteed stream of income starting at a future date. Even if you did not win the lottery or receive a large amount in a personal injury lawsuit, you can still set up your own annuity.
In this annuity buying guide, you will learn who sells annuities, the difference between immediate and deferred annuities, and some basic information about payouts.
Who offers annuities?
Annuities are insurance products. Many insurance companies that sell life insurance, health insurance, and other types of insurance, also sell annuities. There are strict rules and regulations governing the sale of annuities. Insurance companies are required to reserve assets equal to their total outstanding annuity contract obligations. These regulations are in place to protect the contract holders, so that the insurance companies have the funds available to make all future payments on the annuity products they sell.
Deferred annuities are normally used for long-term retirement planning. Money is set aside either in a lump sum (single premium) or a series of payments (flexible premium) and allowed to grow and earn interest on a tax-deferred basis. At some point in the future, usually at least seven years from the purchase date, you can turn on an income stream (annuitize) and you'll start to receive regular monthly payouts. The amount of those payouts (monthly or otherwise) depends on a variety of factors that are spelled out in the contract. In general, you will receive larger monthly payments when the time period between purchase and payout is longer.
An immediate annuity, also called a lifetime income annuity, is where you pay a lump sum of money and you start receiving a payout immediately (usually a month after your premium payment). Immediate annuities can be structured so you will receive income every month (or other specified interval) for the rest of your life, no matter how long you may live.
You can choose different payout options
You will receive a stream of income for the rest of your life.
You will receive a stream of income for life and if you die before your spouse dies, your spouse will continue to receive a payout for the rest of his or her life.
You can choose a specific period for which you want to receive payments like 10, 15, or 20 years. If you die before the specific period of time ends, your beneficiary will receive the income stream for the remainder of the specified period.
Life with period certain
You will receive a stream of income for life, BUT if you were to die shortly after purchasing the annuity, a beneficiary will receive the remainder of the income payments for the period certain selected.
How is the payout determined?
Life insurance companies use actuarial tables and mortality rates to determine how long a person is expected to live. Once they come up with an estimate of your life expectancy, they can make a calculation on how much they can pay out each year. It goes without saying that if you agree to delay the start of your payout until you are age 82, instead of 70 for example, you will be able to receive a higher monthly (periodic) payout.
Annuities are a complicated product
It could easily take 100 pages to fully explain all of the complexities of annuities. Buying annuities can be a great way to assure that you will never outlive your money in retirement. Before buying any annuity, talk with a knowledgeable professional, ask questions, and make sure you fully understand what you are buying.