Annuities are life insurance contracts that provide life benefits and generate income for retirees. Insurance companies sell annuities, which are often contained in pensions, and use actuarial tables to predict life expectancy. Annuity contracts are profitable if annuitants die sooner than expected. Many insurance companies market annuity products to pension providers, while employers prefer mutual fund-based plans due to lower costs.
Annuities are life insurance contracts that provide the contract owner or beneficiary with life benefits. Traditionally, pension plans took the form of annuities; This led many people to use the terms pension and annuity interchangeably. Towards the end of the 20th century, many pension operators stopped using annuity-based pension plans and moved funds into less expensive stock or mutual fund investment plans. Annuity pension plans provide participants with fixed monthly income payments, while share-based plans have no guarantee of benefits.
Both pensions and annuities are designed to generate income for retirees. Insurance companies sell the annuities that are often contained in pensions, and the annuities that individuals can buy as stand-alone products. The insurance company finances the annuity purchase by charging a premium up front. Buyers or annuities receive a return of the premium, as well as interest in a series of roughly equal payments that are structured to last for the life of the annuity.
Insurance providers use actuarial tables to predict the average life expectancy of annuity buyers. Annuity issuers would go bankrupt if payments received by beneficiaries 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 monthly income payments on actuarial tables. The more annuities the company sells, the less likely a high percentage of contract buyers will live longer than expected and put the insurance company in financial jeopardy. From the perspective of an annuity issuer, annuity contracts are profitable if the annuitants die sooner than expected because the issuer pays less than anticipated in terms of life benefits.
Many insurance companies actively market annuity products to pension providers because pension plans have large numbers of participants and annuity providers need to sell annuities to large numbers of people to reduce the risk of loss. Employers and other pension plan providers are sometimes attracted to annuities because the potential income benefits are greater than the initial cost. Also, some workers are more inclined to work for companies that offer lifetime income benefits in the form of pensions and annuities rather than companies that offer pension plans without guarantees.
From the point of view of an employee or an insurer, pensions and annuities are an attractive combination. By contrast, from an employer’s point of view, annuities are expensive to finance due to large up-front premiums and ongoing administrative costs. Many employers prefer to sponsor mutual fund-based plans because administrative costs are covered by the employee and not the employer. While mutual fund plans do not include guarantees, there are also no income limits, so employees could earn more than with traditional pensions and annuities.
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