Annuities provide lifelong income and are often included in pensions, but many pension providers have switched to less expensive mutual funds or stock plans. Insurance companies sell annuities and use actuarial tables to predict life expectancy. Annuities are profitable if recipients die earlier than expected. Employers are attracted to annuities, but they are expensive to fund. Mutual fund plans have no guarantees but no income limits.
Annuities are life insurance contracts that provide the contract or annuity holder with lifelong annuities. Traditionally, retirement plans have taken the form of annuities; this has led many people to use the terms pension and annuity interchangeably. Towards the end of the 20th century many pension providers stopped using annuity-based retirement plans and switched funds to less expensive mutual funds or stock plans. Annuity retirement plans provide participants with fixed monthly income payments, while stock-based plans have no benefit guarantees.
Both pensions and annuities are designed to generate income for retirees. Insurance companies sell annuities that are often contained in pensions and annuities that individuals can purchase as standalone products. The insurance company finances the purchase of the annuity by charging an upfront premium. Annuity purchasers or recipients receive a return on the premium and interest in a series of roughly equal payments structured to last the life of the recipient.
Insurance providers use actuarial tables to predict the average life expectancy of annuity buyers. Annuity issuers would go bankrupt if the payments received by annuity recipients exceeded the premiums annuity buyers paid to purchase the contracts. To reduce the chances of loss, insurance companies sell the same annuity products to large numbers of people and base their monthly income payments on actuarial tables. The more annuities the firm sells, the less likely it is that a high percentage of contract buyers will live longer than expected and put the insurance firm in financial jeopardy. From the perspective of an annuity issuer, annuity contracts are profitable if the annuity recipients die earlier than expected because the issuer pays less than expected in vital benefits.
Many insurance companies actively market annuity products to pension providers because pension plans have large numbers of participants and annuity providers must sell annuities to large numbers of people to reduce the risk of loss. Employers and other retirement plan providers are sometimes attracted to annuities because the potential income benefits are greater than the initial cost. Additionally, some workers are more inclined to work for companies that offer lifelong benefits in the form of pensions and annuities, rather than companies that offer unsecured retirement plans.
From an employee’s or an insurer’s perspective, pensions and annuities are an attractive combination. Conversely, from an employer’s perspective, annuities are expensive to fund due to large initial premiums and ongoing administrative costs. Many employers prefer to sponsor mutual fund-based plans because the administrative costs are covered by the employee rather than the employer. While mutual fund plans don’t include guarantees, there are also no income limits, so employees could potentially earn more than with traditional pensions and annuities.
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