What is a guaranteed lifetime income annuity?

The prospect of retirement may excite you, as you envision spending time with friends and family, pursuing hobbies and traveling. However, you will need income during retirement to maintain your standard of living, pay healthcare expenses and pursue your dreams. Guaranteed lifetime income annuities may be a helpful financial tool to realize the retirement you always imagined. Alongside other retirement accounts, annuities can help provide critical income during your retirement and up until your death, ensuring you don't outlive your savings. Learn more about lifetime income annuities and how they may play a role in your retirement strategy.

What is guaranteed income?

Guaranteed lifetime income is a dependable income stream during your retirement that will continue until your death. It ensures payments will be made to you regardless of your lifespan or market conditions. Guaranteed lifetime income can alleviate concerns about outliving retirement savings. Some common sources of guaranteed retirement income include:

• Pensions — Pensions are retirement programs sponsored by employers, which guarantee payments upon an individual's retirement. The amount received can depend on several factors including age, number of years worked at the organization and salary earned. Pension plans are increasingly rare, as defined contribution plans like 401(k) continue to grow in popularity.
• Social Security — A program administered by the United States federal government, Social Security is designed to help Americans secure income during retirement. Contributions to the program are deducted from individuals' paychecks and the payout amount depends on several factors including your earnings, your age and if you are widowed.
• Annuities — Annuities are a contract between an individual and an insurance company. Once an annuity is purchased, the annuitant makes either a lump-sum or ongoing monthly contributions and then, at a later date, the insurance company agrees to make payments back to the individual for a pre-determined length of time or up until the annuitant's death.

Unlike Social Security and pensions, individuals have some level of control over annuities. Companies can freeze pension plans, halting benefits accrual and changes to Social Security can be made by the federal government at any time. Once an annuity contract is signed and agreed upon contributions are made, the annuity is not subject to change, making it a dependable source of income.

What is a lifetime annuity?

A lifetime annuity is a contract with an insurance company that, once agreed upon contributions are made, guarantees a stream of income until the annuitant's death. These payments are made regardless of market fluctuations. This can help alleviate concerns of outliving your retirement savings or losing your retirement savings due to poor market conditions.

Not all annuities are lifetime income annuities. Term annuities agree to pay a stream of income for a specified period of time, but not necessarily until the contract holder's death. It is possible to purchase both fixed and variable annuities that offer lifetime income streams. This is commonly purchased through what's called a rider, or an additional contract provision that provides additional coverage for specified terms.

Both immediate annuities and deferred lifetime annuities can be structured to deliver a stream of income for life. Immediate annuities simply involve a lump sum contribution and payouts begin shortly after that contribution is made, typically within 12 months. Deferred annuities involve contributions over time and payouts are made at some time in the future to allow for growth.

How do lifetime income annuities work?

The annuity process begins with the accumulation phase, where contributions are made to the annuity, allowing its value to grow tax deferred. During this investment period, contributed funds are invested in various portfolios by the insurance company and earn interest.

Next comes the annuitization phase, where accumulated funds are transformed into a reliable stream of income payments, either for the defined period of time or up until the annuitant's death, depending on the contract. During this payout phase, the annuity holder receives regular scheduled payments for a steady stream of income.

Benefits of lifetime income annuities

Consider some of the benefits of lifetime income annuities when determining if they might be a good fit for your retirement strategy.

• Guaranteed income — Having a guaranteed stream of income during retirement and potentially up until death can allow for more precise budget planning in retirement. Annuities can be used in concert with other income sources including, for example, Social Security, pension income and 401(k) distributions to provide income during retirement.
• Longevity protection — For individuals concerned about outliving their retirement savings, a lifetime income annuity may be a good investment because it guarantees income until your death.
• Tax-deferred growth — Annuities offer tax-deferred growth, meaning that money grows over time and distributions are taxed at your effective tax rate at the time you receive them.
• Customizable — Annuities are highly customizable. Not only are there many different types of annuities but, for additional fees, there are also riders that allow you to customize annuity benefits in a number of ways.

Types of lifetime income annuities

There are a variety of annuities available to meet your specific retirement needs, your income level and your tolerance for risk. Read on to explore some of the different types of lifetime income annuities.

Immediate vs. deferred lifetime income annuities

Depending on your age and how close you are to retirement, you may choose an immediate or deferred lifetime income annuity. If you are close to retirement age and would like to start receiving annuity payments within the next year, for example, an immediate annuity may be right for you. You may, for example, choose to take some of your savings from a 401(k) or other retirement account, and invest in an immediate annuity to begin receiving payout in the next year.

If you're younger and retirement is several years or decades away, a deferred annuity would allow you to make contributions over time, giving that money the opportunity to grow over time. If you choose a variable deferred annuity with a lifetime guaranteed rider, you will be able to choose where your funds are invested from a given number of investment options.

Fixed lifetime income annuities

Fixed annuities guarantee a specific rate of interest on your annuity contribution, allowing you to depend on a specific payout amount each and every month for the duration of the contract term or up until your death. Fixed annuities offer the stability of predictable payments. At the same time, your fixed annuity payout may not cover your expenses as planned if inflation rises.

Variable lifetime income annuities

Variable annuities offer greater growth potential than fixed annuities. Variable annuities offer the opportunity for you to choose where your contributions are invested among a given number of options provided by the insurance company. This means that contributions grow tax deferred, depending on the performance of the underlying investments, offering the potential for a greater return (or loss) than is possible with fixed annuities. A lifetime income variable annuity may be a good choice if you'd like some level of control over how the contributions are invested. Variable annuities may also provide some growth that could help cover inflation. However, if you're risk averse, a variable annuity may not be the best choice for you, as there is no limit to the potential gains and losses unless additional riders are purchased.

Indexed lifetime income annuities

Much like a variable annuity, an indexed lifetime income annuity offers the potential for greater growth than a fixed annuity. An indexed annuity links your interest earnings to a market index such as the S&P 500. However, indexed annuities cap growth potential but also offer principal protection, making them less risky than variable annuities. An indexed lifetime income annuity offers some growth potential with a limit on potential losses, combining features of both fixed and indexed annuities.

Hybrid lifetime annuities

Through the purchase of riders and/or multiple annuity products, it's possible to benefit from a combination of annuity types to achieve a guaranteed lifetime income. This means a portion of your contributions may be allocated to a fixed annuity and another portion to a variable annuity. The purchase of riders can also offer protection of your principal or inflation protection. The hybrid option may allow you to achieve just the right balance between guaranteed lifetime income and growth potential, but it requires a good understanding of annuities and can also be associated with high fees. Consult with a financial professional to determine what combination of annuities and/or riders may work best for you.

Optional riders

Riders are add-ons that allow you to customize an annuity. Riders can help ensure the annuity you invest in meets your specific needs and retirement goals.

• Guaranteed minimum income benefit (GMIB) — For an additional cost, you can purchase a GMIB rider. This rider is an additional feature that guarantees a minimum stream of periodic payments, even if market performance is poor. This rider can help ensure you will not run out of retirement income prior to your death. However, it involves higher fees, potential limitations on investment options and can come with other restrictions.
• Cost of living adjustment (COLA) — A COLA rider can help ensure your income payments keep pace with inflation. This kind of rider typically uses the Consumer Price Index (CPI) to determine the annual percentage increase. As with all riders, this option will increase the cost of the annuity.
• Death benefit rider — A death benefit rider guarantees a payout to your named beneficiaries upon your death. Typically, the payout is either the premiums invested or the account value, whichever is greater. This can help provide financial protection for your beneficiaries upon your death, who can receive payments as either a lump sum or as payments over time.

Considerations before purchasing

There's a lot to think about before purchasing an annuity. It's important to take into consideration your own retirement needs as well as the specifics of the annuity. Here are some things to consider when purchasing an annuity.

• Fees and charges — Annuities often come with more intricate fee structures compared to other types of retirement investments and accounts. Annuities typically incur higher and more complex fees to compensate the life insurance company for the risk of providing a guaranteed income stream. It's crucial to review your annuity contract for specific details, but common fees associated with annuities include administrative fees, commissions, surrender charges, rate spread fees, and mortality and expense fees.
• Financial strength of the insurer — Since an annuity involves a promise to pay a guaranteed stream of income at a future time, it's important to ensure the insurance company is a strong, dependable entity in good financial standing. Take time to review the company's financial rating from a trusted source such as AM Best, S&P Global Ratings or Moody's.
• Inflation impact — While you may have your retirement budget mapped out down to the penny, it's important to account for inflation. Depending on how far you are from retirement age, inflation may have a significant impact on how far your annuity payments will take you in retirement. Carefully evaluate inflation trends and consider that as you choose to invest in annuities and other financial vehicles.
• Liquidity needs — Annuities offer tax deferred growth but limited liquidity. If you believe you will need access to your money, you'll need to carefully consider if an annuity is right for you or consider a rider such as a Guaranteed Lifetime Withdrawal Benefit to ensure you can access money penalty-free.

How to choose the right annuity for you

Here are some steps that may help guide you through the process of choosing an annuity that meets your retirement goals.

Step 1 — Assess financial goals

The first step is to determine your expected expenses in retirement. Compare those with your other sources of income during retirement and identify gaps between expected expenses and income. Ask yourself these questions:

• How much income will you need in retirement?
• What other sources of income can you depend on during retirement?
• Do you think you may outlive your retirement savings?
• What is your expectation for growth of your retirement savings?
• What is your tolerance for risk?

Step 2 — Evaluate different annuity types and features

There are so many different types of annuities to choose from, all of which can be customized with additional riders. Sorting through the specific provisions of each can be challenging. It may be helpful to outline the pros and cons of each type of annuity and make a checklist of provisions they fulfill. For example, if you know you want to access a guaranteed stream of income, but you are worried that the payments from a fixed annuity would be eroded by inflation, you may want to consider investing in an indexed annuity with a GMIB rider. This would provide a guaranteed stream of income but have the potential for your principal to grow with the market.

Step 3 — Seek advice from a financial professional

It's always a good idea to seek assistance from a qualified financial professional. Navigating all the options available with annuities can be complicated. A qualified financial professional can help you align your personal retirement strategy with the annuity product/s that best meet your needs.

Frequently asked questions

What happens to a lifetime income annuity when you die?

What happens to a lifetime income annuity upon your death depends entirely on the specific features and riders outlined in the annuity contract. A life-only annuity would stop payment upon your death. However, if you purchased any number of riders, payments might continue to your spouse or named beneficiary for a specified length of time. In other cases, the principal invested may be returned to your named beneficiary.

Do lifetime income annuities pay a death benefit?

Once again, the delivery of a death benefit depends on the provisions of the annuity contract. A Guaranteed Return of Premium annuity rider can ensure your principal less any fees and withdrawals, is distributed to your annuity beneficiaries upon your death. Some annuities offer a guaranteed death benefit. Consult your insurance company or a qualified financial professional to ensure you invest in an annuity that offers this feature if it's something you need.

Will my spouse continue to receive payments after I pass away?

Some options are available such as joint and survivor annuities, which would provide a surviving spouse continued annuity payments. As always, check the provisions of your specific annuity contract.

Can I access my money if needed?

While annuities may be an effective vehicle for achieving tax-deferred growth, they don't necessarily offer a lot of flexibility to access your money. It is possible to make withdrawals from your annuity, but you will be required to pay fees and penalties. Some riders may offer limited access to funds in your annuity.

How are lifetime income annuity payments taxed?

Annuities are tax-deferred, meaning you don't pay taxes on any growth until you start receiving payments. At that time, payments are taxed as regular income at the time of their disbursement. Your effective tax rate may be lower when you are retired than it was when you were at the peak of your earning years.

Securing your financial future

Annuities are not always top of mind when individuals are planning for retirement, but they are well worth consideration as a part of a comprehensive retirement strategy. Lifetime income annuities may be able to provide a guaranteed stream of income until you die, ensuring you don't outlive your retirement savings. Explore Protective's Learning Center to learn more about the different types of annuities.