A whole life annuity is a financial product offered by insurance companies that provides regular payments to an individual for their entire lifetime, starting at a specified age. This form of annuity is ideal for those seeking to ensure a steady income stream during retirement.
Key Takeaways
- Annuities are financial products designed to deliver scheduled payments over time, potentially covering the lifetimes of the policyholder and their spouse.
- A whole life annuity guarantees payments for the individual’s lifetime, commencing at an agreed-upon age per the contract terms.
- Payment frequencies can range from monthly to annually, based on the policyholder’s choice.
- Annuities can offer fixed rate payouts, which are unaffected by investment performance, or variable rates, which fluctuate with market conditions.
- Variable annuities typically allow investment in diverse funds to improve portfolio diversification.
Understanding How Whole Life Annuities Work
Whole life annuities can be designed to deliver payments either for a set period, such as 20 years, or for as long as the annuitant and possibly their spouse live. Insurance company actuaries utilize mathematical and statistical models to assess risks and set appropriate policies and rates.
The life cycle of an annuity consists of the accumulation period, during which the policy owner makes payments to the insurance company, and the annuitization phase, when the insurance company starts distributing scheduled payouts to the annuitant.
Special Considerations
Annuities generally fall into two broad categories: fixed or variable. Fixed annuities promise consistent, regular payments, whereas the payouts from variable annuities depend on the performance of investments within the annuity fund. This means that variable annuities can offer higher or lower future cash flows, reflecting the performance of these underlying investments.
Variable annuities commonly permit investment in various assets, such as stock mutual funds, providing potential for higher returns but also greater risk when compared to fixed annuities.
There are no IRS limitations on contributions to annuities, and earnings are only taxed upon withdrawal. It’s important to note that taxable withdrawals before age 59½ may incur a 10% IRS penalty in addition to ordinary income taxes.
Agents or brokers selling annuities must hold a state-issued life insurance license and, in the case of variable annuities, a securities license as well. They typically earn a commission based on the notional value of the annuity contract.
Inspirational Example of Utilizing a Whole Life Annuity
Considering a 6% annual rate of return, a $100,000 lump-sum investment in a taxable account would grow to $222,508 over 20 years. In contrast, a tax-deferred variable annuity with a 0.25% annual charge would be worth $305,053 pre-tax at the end of the term. If the investment is withdrawn as a lump sum (post-tax), the value would be $239,436, accounting for applicable taxes.
Related Terms: Retirement Planning, Fixed Annuities, Variable Annuities, Lifetime Income Stream, Tax-Deferred Investments.
References
- Internal Revenue Service. “Publication 575, Pension and Annuity Income”, Page 33.
- FINRA. “Insurance Agents”.
