Surrender charges are one reason that consumers should not attempt to use annuities as short-term, liquid investments in the same way they might deposit accounts. Some annuity contracts do offer loan privileges where the policy owner may borrow against the contract instead of accepting a distribution of cash. Besides this negative, a policy loan is also considered taxable income.
Determining the Mathematics of Fixed Annuities
The cost of an annuitys benefit is included in the premium paid for the annuity. Insurance companies use demographic projections as well as complex mathematical calculations to develop and price the annuity products they sell. A company must use projections on average life expectancies when it prices its products, because the number of years people will live directly relates to the amount that the company pays out on its annuities. In turn, statistical projections on the average number of people who will die at different ages influence the amount a policy owner must pay for an annuity.
One important mathematical device insurance companies use for pricing annuities is a mortality table. A mortality table is a mathematical tool used to calculate the frequency of deaths that will occur between successive birthdays. The numbers in a mortality table are calculated through the use of mathematical equations that express the probability or likelihood of the occurrence of a specific event.
Mortality tables are developed by actuaries. Actuaries are insurance specialists who are experts in mathematics. Actuaries calculate risks, premiums, reserves, and other mathematical factors for insurance companies.
The numbers in a mortality table allow an insurance company to project its likely future obligations to annuitants. Similarly, the company uses the mortality table to project how many dollars will be released to it by annuitants who die. This information, together with statistics the company gathers on the interest it can earn on its holdings, is then used to calculate the premiums to be charged for annuities as well as their other products.
Investor Considerations Fixed Annuities
The promise of a guaranteed lifetime income during retirement may be attractive to many investors. However, a guaranteed income is only one factor that should be considered when considering annuities. Among the other issues that should be examined carefully are risk, liquidity, earnings, and taxes.
Annuities are relatively safe investments. While they are not covered by federal deposit insurance, the principal and interest an individual invests in a fixed annuity contract are provided by the rigid state and federal regulations that govern insurance companies operations. However, these regulations do not protect an investor from all potential problems.
If the insurance company that sold an annuity to an individual experiences severe business problems and becomes insolvent, other insurance companies doing business in the same state will be required to help meet that companys remaining obligations. However, the annuitant may face extra paperwork and delays in attempting to obtain funds.
Additionally, it is a good idea to research the soundness of the insurance company before purchasing an annuity from it.
Annuities are relatively liquid investments because they provide ways for individuals to surrender their contracts and withdraw their funds during the accumulation period. They are not completely liquid, however, since investors ount that they have paid in premiums if they ount that an individual would lose depends on the surrender fees and penalties assessed by the insurance company. These charges are described in the annuity contract.
Interest earnings on annuities have attracted many current investors. Guarantee periods vary with different insurance companies. Some will pay an initial rate for one or two years followed by subsequent annual guarantees. Others will peg their rates to formulas based on Treasury bill or consumer price indexes.