Life Annuities: What to Watch Out For When You Buy

By Chantal Marr,

Special to the Financial Independence Hub

An annuity is a type of investment sold through insurance companies. You can think of a life annuity as a life insurance policy in reverse — you pay the insurance company a large lump sum of cash and in return the insurance company pays you monthly premiums for life.

This can act as a form of retirement income after you leave the work force. Although life annuities can be a great option, here is some advice on the things you should look out for when it comes to life annuities.

Know the Difference between Immediate and Deferred Annuities

You should understand and watch out for the language in an annuity agreement. There is language that will signal if the policy is an immediate or deferred annuity. As its name implies, an immediate annuity means that you will obtain your fixed payments right away. There will be no delay in receiving your money. A deferred annuity is different. It offers some flexibility as to when the payments start, and is at the discretion of the owner of the policy. For example, you can have the payments start when you retire from the work force.

Understand Fixed and Variable Options for Annuities

Before purchasing an annuity, you’ll need to decide if a fixed or variable option is right for you. This will depend largely on your personal circumstances. If you are not approaching retirement age and are still in the work force, and plan to be for quite some time, it might be to your benefit to consider a variable annuity. For the sake of full disclosure, variable annuities carry a higher risk because of the nature of the stock and bonds market and its tendency to fluctuate.

On the upside, variable annuities may show substantial growth because of the high returns. This could be a smart choice when you and your annuity are still relatively young, healthy and your annuity can ride out some fluctuations in the market. Fixed annuities are far more appropriate for those approaching retirement age and for those people who have owned the annuity for a number of years. These annuities are far more secure and the money is less at risk because of fluctuations in financial markets.

What are Your Other Annuity Options?

There are also some other options you can consider when you are setting up an annuity. You may have a spouse or partner that you want to protect in the event of your death. A joint-and-last survivor option on your annuity will pass on your annuity payments to your spouse if you pass away before the expiry of the guaranteed term. Payments end when both partners pass away.

One thing you will need to watch out for is that this will decrease the amount of the annuity payments you receive. Another option to consider is to add a guaranteed benefit to the annuity so that if you and your spouse are gone, you can designate a beneficiary who will continue to receive payments for the remainder of the agreed term. This could be a 5-, 10- or even 20-year time span.

Another reality of the economy is inflation. If you want your annuity to keep pace with inflation, you could add on an indexing option where the company will anticipate inflation, and it is calculated into the price of your premiums. This usually means that contributions will start at a lower rate and increase as time goes by.

Shop Around for Your Annuity

It really does pay to shop around for your annuity options. There are many life annuity companies in Canada and you can save up to $20-$80 per month depending on the company and the size of the annuity. Check out this information on pricing to see how different companies compare to each other for the type of policy that you want. You can even check up on the reputation of the company and find out how well it meets its payment obligations to its customers.

Any additional guarantees come at a cost to the consumer, as the more guarantees you receive, the lower the income you receive.  Some tips to keep in mind are that you should understand the difference between immediate and deferred payments; also the fixed and variable annuity options. You should also make sure that you shop around and add on options such as joint and guaranteed benefit add-ons for your policy.

Drawbacks

Two things to keep in mind are pointed out by GetSmarterAboutMoney.ca. First, unless you add inflation protection, annuities are not geared to accommodate inflation. Make sure you consider your future cost of living, and the type of lifestyle you want if you are depending on an annuity. Secondly, payments end when you die. This means you may wind up paying more into the annuity than you receive.

Nevertheless, an annuity can be a very smart decision for retirement income. Don’t leave yourself and your loved ones unprotected in your senior years. Weigh the pros and cons and consider purchasing an annuity for your long term financial security.

Chantal Marr is President of LSM Insurance, a leading Canadian life insurance agency, where she is in charge of product development. She has a B.A. from Laval University and Bachelor of Education from the University of Western Ontario. Chantal is a member of the Independent Financial Brokers of Canada, which gives her the flexibility to deal with all major Canadian life insurance companies. She is fluent in both English and French.

Connect with Chantal on LinkedIn and Twitter.

For more info on Chantal and others on the LSM Insurance team, click here.