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birb_cromble  1mo ago (text post)   1044 thread views

Weekly Finance Thread - 2026-06-13

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Can someone more knowledgeable than I am explain what the purpose of an annuity is? They seem like a fixed income investment bound together with a life insurance policy. Is that the whole point? Am I missing something that makes them more attractive than that?

I've always thought of it as using a lump sum to buy yourself a pension (or a larger pension if you already have one), but that could be in error.

Reo is partially right, but definitely needs some clarification:

Term Life insurance:

  • Is generally cheap (think more $300 a year, not $1000) but gets more expensive as the policy approaches EoL.
  • Is for covering unexpected premature death, but that's about it (basically get an amount that would cover your mortgage)
  • 97% of the time expires without use

Whole Life + whole life variants

  • More 'costly' in that a policy will be a more expensive monthly premium for less coverage
  • Is permanent, meaning that it will pay the death benefit to your family upon end of your life
  • Usually has a number of different riders and additions to be tailored to your needs
  • Turns into an 'owned' asset which you can take out loans against
  • There's a number of tax things as well

Annuity:

  • Is an insurance for when you're alive
  • Generally appreciates in value over time at a fixed rate and usually pays a guaranteed monthly payment starting at a certain period in your life.
  • Money added to the annuity grows tax deferred until annuitization (the time when annuities pay out a fixed income)
  • Can be tied to the market in various ways
  • While it can be used as an inheritance vehicle, if you die during annuitization, the insurance company usually keeps the leftovers (this is an incredible oversimplification. there's a lot of different ways an annuity can be structured which change the payout structure).
  • usually has a lot of fees, so be very careful about the annuity (though there is something called a 1035 exchange which allows you to replace an annuity to one that is a better offering).

They are a means to have fixed income for you. And they are (usually) issued by life insurance companies.

Normal Term Life Insurance:

  1. at age 30, you pick a term life insurance to safeguard your family.
  2. You pay $1000 (called premium) to the insurance company every year and depending upon the risk of you dying, the company assesses its risk, and is ready to pay your family in case of your death, a sum assured amount like say $1 million.
  3. if you don't die in year 1, you pay $1000 next year (as premium) to continue having this benefit for your family.
  4. You do this for the term of your insurance policy. Say 30 years.

Normal Fixed Annuity:

  1. At age 60, you look at your portfolio and say that you need some kind of income throughout the rest of your life.
  2. You go back to the life insurance company, and pay it $1 million and the company says, okay now you got an income stream which we will pay throughout your life period. There are multiple options in an annuity and based upon the parameters, the company will pay higher or lower amount.
  3. If you don't have anyone around you, so you say to the company, I just want an income for my life, after that keep the amount with you. Depending upon how long the company thinks you may live, it can offer $60,000 a year all your life.
  4. If you have a kid(s) or some nephew/niece for whom you want to leave that $1M, you tell the company, I want an income stream while I live, then you give back that $1M to my nephew XYZ. So, they will reduce the amount to give to you, and will pay out say $30,000.
  5. Then there are variable annuities, inflation step up annuities, joint life annuity, joint life annuity with Principal back, etc.

So it's a bet between you and the insurance agency that you're going to live longer than they think you will?

You can say that. They are taking the bet, so they indeed think that they will make money in this. While you are shifting the risk of running out of money during your lifetime to them. Both sides get something out of the transaction.

A good insurance agency shouldn't force you to make the distinction. You should get a guaranteed income in retirement with a fixed tax deferred growth for a set amount of time. There are many ways to structure an annuity that should prevent the "betting" angle of a fixed annuity. Generally, if the annuity runs out of money the annuity won't provide income beyond the principal+fixed growth of the annuity.

It can also be a tool for people who are bad with money. One of my plans was to buy an annuity that would cover taxes/utilities just in case I predeceased my husband. Sometimes his ADHD would be his worst enemy so it would have made me feel better to know he would have some basics taken care of without needing to think about them. (Generally annuities aren't a good bet, imo.)

A pretty loaded bet, I think, they charge a big premium. It makes people feel safer though.

It's kind of the opposite of life insurance, really. The point of an annuity is that you can't outlive it, so you purchase annuities as a hedge against living longer than you anticipate, where life insurance is a hedge (you erect for others) against dying sooner than you anticipate. I think many annuities also have death benefits associated but I assume that is to mitigate unjust windfalls to the brokers.

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