Understanding Purchased Life Annuities:
Purchased life annuities (PLAs) are financial products that provide a regular income stream to individuals in exchange for a lump-sum payment. These annuities are typically purchased from insurance companies and offer a fixed income for the rest of the annuitant’s life.
Key Points about Purchased Life Annuities:
- Definition of Purchased Life Annuities:
- Purchased life annuities are insurance contracts where an individual pays a lump sum of money to an insurance company in exchange for a guaranteed income for life.
- Unlike traditional annuities, which are funded over time through regular contributions, PLAs require a single premium payment upfront.
- Features of Purchased Life Annuities:
- Fixed Income: PLAs provide a predetermined income amount that remains constant throughout the annuitant’s life, regardless of economic conditions or market fluctuations.
- Lifetime Payments: The income from a PLA continues until the death of the annuitant, providing financial security and stability in retirement.
- No Investment Risk: Since PLAs are not linked to investment performance, annuitants do not bear the risk of market downturns or fluctuations in interest rates.
- No Cash Value: Unlike some other types of annuities, PLAs typically do not have a cash surrender value or the option for partial withdrawals.
- Example of Purchased Life Annuity:
- Suppose an individual, John, aged 65, decides to purchase a PLA with a lump-sum payment of $100,000.
- The insurance company calculates John’s life expectancy based on factors such as age, gender, and health status.
- Using actuarial calculations, the insurer determines the monthly or annual income John will receive for the rest of his life, considering his life expectancy and the amount of the lump sum.
- John starts receiving regular income payments immediately, providing him with financial support in retirement.
- Benefits of Purchased Life Annuities:
- Guaranteed Income: PLAs offer a reliable source of income that is not subject to market volatility, making them suitable for individuals seeking financial stability in retirement.
- Lifetime Protection: Annuity payments continue for as long as the annuitant lives, ensuring that they will not outlive their savings.
- Simplicity: PLAs are straightforward financial products with no complex investment choices or ongoing management required.
- Considerations for Purchasing a PLA:
- Initial Investment: Annuity providers determine the income amount based on factors such as the annuitant’s age, gender, prevailing interest rates, and the size of the lump sum.
- Inflation Protection: Since PLA payments are fixed, annuitants may face a decrease in purchasing power over time due to inflation. Consideration should be given to options for inflation protection.
- Health Status: Annuity providers may offer enhanced annuity rates for individuals with certain health conditions that could affect life expectancy.
- Tax Implications of PLAs:
- Income received from PLAs is typically subject to income tax, similar to other forms of retirement income such as pensions or annuities.
- Tax treatment may vary depending on factors such as the annuitant’s age, tax residency, and local tax regulations.
In conclusion, purchased life annuities offer individuals a simple and reliable way to secure a guaranteed income stream for life. By understanding the features, benefits, and considerations of PLAs, individuals can make informed decisions to support their financial goals in retirement.
Reference: Purdy, G. (2017). The Retirement Annuity Book. Harriman House Limited.