An annuity is a financial product paying an income stream to the buyer for a period of time. The income stream is paid monthly (or quarterly, semi-annually , or annually).
The person receiving the income is usually the buyer or, spouse or, children of the buyer. An annuity contract usually includes a purchaser, an issuer of the contract, usually an insurance company. When purchased with a superannuation lump sum the recipient of the regular income is restricted to the buyer or spouse.
Purpose of annuity
These contracts are usually intended to pay an income for the life of the person or lives of two persons . The term of the the income stream may however be fixed, such as 10 years. When an annuity is arranged for the lifetime of a person the arrangement is referred to as a lifetime annuity. The term for which the regular payments will therefore be paid for is the uncertain lifetime of the annuitant (the person entitled to the income). This is the key benefit of an annuity.
Benefits of annuity
The benefit is that the person receiving the income stream will receive a fixed payment over a period of time. They know exactly how much they will receive and when. If taken for life then the annuitant cannot outlive the income stream. If an annuity is taken out to last the lifetime of the persons receiving the income stream and they live longer than expected it will be to their advantage. This is the unique benefit of an annuity—it eliminates the risk of personal longevity.
Risks of an annuity
As the income stream is fixed, with inflation, it will not maintain its purchasing power. If the person receiving the regular income dies soon after entering into the annuity contract, some of their money will have have been forfeited to the issuer. So there is no protection of income against inflation and there is no preservation of capital.