Annuities Explained

How Do They Work?

Annuities are purchased to provide stable growth as well as capital and income guarantees for long term savings. Growth is provided through competitive interest rates, while guarantees are backed by an insurance company’s capital.

Unlike short term low interest instruments such as certificates of deposit and savings accounts, annuities have higher interest rates and longer terms which are usually seven years or longer. To provide attractive long-term interest rates, insurance companies build up high quality bond portfolios.

Most of the interest earned from this portfolio is paid out to their annuity clients and they keep a small margin to cover their operational expenses and profit. Since insurance companies guarantee the principal invested in annuities, insurance companies are required to have strict cash reserves invested conservatively.

How do they Provide Income?

In addition to providing an attractive interest rate and safety for long term savings, annuities can also be used to manage longevity risk. In other words, annuity clients concerned with outliving their savings can choose to transfer this risk to the insurance company by selecting a benefit that guarantees a lifetime income. This risk transfer capability is what differentiates insurance companies from other types of financial service institutions.

Through this benefit, the insurance company guarantees a monthly income that will continue even if the funds deposited in the annuity have been completely depleted through systematic withdrawals. There is a fee associated with this benefit. This benefit is known as Guaranteed Lifetime Income Benefit and it’s a good option for people looking for the practical and emotional benefits of having an income source that’s secure and reliable.Like principal guarantees, the Guaranteed Lifetime Income Benefit is guaranteed by the insurance company’s cash reserves.

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