What Is an Income Annuity?

Having life insurance is an important part of your long-term financial plan, but there are some circumstances that may necessitate the use of supplemental services — like income annuities. Read on to find out what exactly an income annuity is, how it works and if it’s right for you.

What Is an Income Annuity?

Not to be confused with life insurance, income annuities are financial products designed to provide a stream of income for a specified period, typically for the duration of a person’s life. Think of them as a long-term financial safety net with a twist. You can either contribute a lump sum or pay into it over time – kind of like a savings plan – and, in return, you get a steady stream of income immediately or in the future, usually when you retire. It’s sort of like giving yourself a paycheck even when you’re not working anymore, which is particularly valuable for retirees who do not have access to traditional pension plans or who have exhausted other sources of income. 

Income annuities come in two varieties – immediate or deferred income. Income annuities offer protection against longevity risk, as well, which is the risk of outliving one’s savings. By providing a guaranteed income for life (or a specified term), annuities ensure that retirees will not run out of money, regardless of how long they live.  

“People often like the idea of their money earning a guaranteed interest rate and transferring longevity risk to the insurance company,” says Costantino DeTore, life insurance and annuity specialist with AAA Northeast.

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How Do Income Annuities Work?

In order to get the benefits of an income annuity, you must either contribute a lump sum or pay regular premiums to your insurance company. In exchange, a person receives the promise of future guaranteed income payments. These future payments are based on various factors, including age, gender, interest rates and the length of the term. When you reach a certain age or retire, the insurance company begins paying you back in regular installments, similar to how social security operates.

There’s a good amount of flexibility when it comes to income annuities, too. It’s up to you how long you’d like to receive payments for, whether it’s for a specific number of years or for life. During this time, you receive regular payments, typically on a monthly or annual basis. “If you are concerned about a spouse running out of money, an income annuity can pay lifetime income over both person’s lives. Any remaining balance can also be transferred to children or loved ones,” DeTore said.

Income annuities bring some tax benefits, too, which is always a bonus when it comes to money matters. While the specifics vary depending on the jurisdiction and the type of annuity, in many cases the income deferred or received from annuities can be designed to maximize tax efficiency.

What Else Is There to Know About Income Annuities?

There are some potential drawbacks and limitations to consider before opening an income annuity.

First, it’s important to remember that most income annuities are not suitable if you anticipate needing your money back in a lump sum or for emergencies in the short term. This means that annuities should be considered in coordination with a full needs analysis — while being mindful of short-term and long-term financial goals.

While they offer stability, some income annuities do not provide payments that keep up with inflation over time, essentially decreasing their initial purchasing power. Some income annuities do provide this feature, so it is important to work with a financial professional that can match your needs with the right solution.

Talk to a AAA insurance specialist about an income annuity today.