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Aug 12 2008

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Annuities: The Unsung Heroes

Annuities: The Unsung HeroesWhat is an annuity?

Annuities are an under-utilized product for those seeking consistent stable income, regardless of stock market conditions. In simple terms, an annuity can be thought of as the opposite of a mortgage for a home. With a mortgage, a financial institution gives you a specific amount with which to purchase a home and in turn you make regular payments back to them. With an annuity, you give the financial institution a specific amount and they in turn make regular payments back to you. This article is a brief overview of two primary types; the “term-certain” and the “life” annuity.

Term Certain

With a term certain annuity, you trade a pool of capital for a guaranteed fixed payment each month for a specific time period. A typical term-certain annuity might be for a 5 year, fixed term of $500 per month. The key determinant of cost will be interest rates at the time of purchase.

Situations where you might consider a term-certain annuity;

  • to reduce on-going investment decisions,
  • a simple and secure source of income,
  • an income need for a specific time period,
  • to convert savings into income to fund a child’s on-going educational costs, or
  • to transfer inheritances to children gradually (versus a one-time lump-sum).

Life Annuity

With a life annuity, you trade a pool of capital for a guaranteed income for life. You might think of it as buying a pension. The key factors in how it’s priced are your age, whether you are male or female, whether the invested funds are registered or non-registered, and current interest rates. You can also specify whether you want it indexed (i.e. increased payment by 2% each year), joint with your spouse so its lasts until the death of the last survivor. There are hosts of other customizing options available to suit your financial planning needs.

You should also be fully aware that it’s a one-time decision and once you trade your capital for that guaranteed payment going forward, the capital is no longer accessible by you, nor can it be passed along to beneficiaries should you die. If this is a concern, one option at the time of setting up the annuity, might be to specify a “guarantee period” i.e. a five year guarantee period. Then in the event you pass away after two years, the balance of payments (remaining three years) would go to the beneficiary.

In summary, annuities may be worth considering for your financial plan. They are very flexible and can be customized to meet a wide range of needs.

For more information about annuities, click here.

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