Annuities are arrangements or investments that essentially organize pots of money. Most commonly, annuities are arrangements made by people looking to convert their pension savings into regular payments that last until the end of their lives. We outline what are annuities and the differences between the various types of annuity you might consider.
Annuities are convenient for people who want to guarantee a steady stream of money to live on after they retire. They are not appropriate for everybody, so be careful before you invest in one. If you shop around wisely, they can be a great way of organizing your pension money.
What are annuities?
Annuities are a kind of insurance. The issuing company is insuring the buyer against the possibility that they might outlive their savings. Even if you run out of savings, an annuity provider will pay you your regular amount because that possibility is what you have paid a fee to insure against.
Types of annuity and how they differ
There are several types of common pension annuity. This article gives a brief overview of each one.
Level
The most basic kinds of annuity for sale are known as level annuities. A level annuity pays the same quantity of money every single month or year. This makes them very easy to understand, as the rate of payment is guaranteed in absolute terms. Unfortunately, level annuities do not account for inflation, so while you might be paid the same amount of hard currency, there is no way of telling just how much that currency will actually be worth. This kind of annuity is not recommended unless you need to simplify proceedings or have alternate savings available.
Inflation-Linked
Whether you are shopping around at banks or buying annuities online, it is always good to check whether a provider offers inflation-linked annuities. These annuities account for inflation rates so that you never get short-changed. Inflation has been rather unpredictable over the last 150 years, and several wars and stock market crashes have sent currency prices spiraling out of control. Accounting for inflation and devaluation is essential.
Impaired or Enhanced
These annuities pay out a higher amount if your health affects your expected lifestyle during the period in which you are being paid. This is a rather grim trade-off, where the insuring company is able to guarantee you more money because there is less of a chance of you living long enough to run out of funds. Rates are often very good for these annuities.
Joint Life
Joint life annuities will payout to a spouse or partner in the event of your death. This can help ease your mind if you believe that your partner’s financial situation may be precarious after you pass away. They typically have relatively bad rates and are not recommended over life insurance.
Short Term
Short-term annuities – otherwise known as fixed-term annuities- allow you to invest a fraction of your pension fund into a scheme. These plans are useful if you believe that rates will get better in the future or if you have alternative plans for investing your savings.
Conclusion
In comparison, payments into the statutory pension (without employers’ participation) only pay off after about 18 years, while private pensions only show a plus after about 30 years. Is it worth it? – is, of course, an obvious question. After all, life is finite. A current study by the Institute for Economic Research shows one thing very clearly: From a statistical point of view, such payments are worthwhile for high earners much more often, because the inequality between rich and poor in terms of life expectancy is growing.
Occupational groups for which the amount of the statutory pension only reflects the social status in a distorted manner (self-employed, civil servants) were not taken into account in the study. The researchers were able to deduce how long the pensioners were still alive from the length of time they were drawn.
The result: the life expectancy of those with high salaries has grown considerably faster than the life expectancy of their peers with low pensions. In 2005, 65-year-olds with very high pension benefits had an average remaining life expectancy of just under 19 years.
The bottom fifth of the income, however, usually did not reach their 80th birthday. After their 65th birthday, they only have an average of 15 years left – that is, four years less. While this difference was around three years in 1997, it widened to more than five years by 2016.
Life expectancy has increased in all income groups, but while it only increased by 1.8 years in the lowest income group from 1997 to 2016, the upper group gained almost twice as much life in the same period.
According to the results of the study, there are good demographic reasons for improving low pensions: If you only receive a short pension, your annuity should at least be higher, one could argue.
