Life Annuity

Categories: Insurance

See: Annuity. To life, to life, l'chaim.

In an annuity, you pay a chunk of money now, and at some point in the future, the company you paid starts paying you fixed payments on a regular basis.

The details of an annuity differ from product to product. Some pay out for a set period of time...say, 20 years or something like that. A life annuity doesn't have a fixed time period. It keeps paying out as long as the recipient is alive.

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Finance: What is Annuity?58 Views

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finance a la shmoop. what is an annuity? a new it tea? maybe like you know the ones

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that Instagram models advertise. yeah those. no it's not new. but the a new [picture of tea]

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thing there at the beginning of the word no nothing to do with proctology. get

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your head out of there. the ANU is short for annual- and that's the kind of you

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know derivative of the word there that applies. an annuity is a kind of weird

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insurance policy with hundreds of twists and flavors and special options

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investors can buy. let's say that the wonderful Cathy clueless invests a 100

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grand in an annuity when she's 52 years old and she does nothing. from the way

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the annuity contract is set up when she the investor turns 72 which is when she

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plans to fully retire from her career as a professional interpretive dancer, she

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can withdraw a thousand dollars a month for as long as she lives. so you think

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hmm this is a weird shell game right? well she put in a hundred grand 20 years

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earlier and now she gets a grand a month for as long as she lives. well how long

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will she live? and what happened to that hundred grand ?it was that a good deal or

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a bad deal ?well first things first the insurance company will likely have a [man frowns]

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decent actuarial table to estimate how long interpretive dancers live. that is

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they take data on factors like you know how often Cathy goes to CrossFit, whether

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she engages in healthy habits like texting and driving, and you know the

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food she eats and if she takes part in any dangerous activities like you know

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skydiving. and well then they estimate and she lived to be 90 that is she'll

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live 18 years after age 72 which is when she starts getting that grand a month or

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eighteen times 12 and yes we're gonna ignore time value money here for a

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moment. that equals 216 months of collecting a

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grand a month from her annuity and you may think all those insurance companies

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they're suckers. they made a bad deal. but then you look at their nice collection

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of jets and buildings and your probably wrong yeah. well they only took

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in a hundred grand and they have to pay out two hundred sixteen thousand dollars? [equation]

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well yeah let's go back to the offices. there of fools gold insurance. do they

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look like suckers no actually give suckers to buyers, but that's a different.

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story so forensicly we go back to the original hundred grand that Kathy gave

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to the insurance company. remember that rule of 72? yeah that one .will you take

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the compound interest rate at which some investment grows, divided into 72 and

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that's how long it takes to double. well the insurance company has historically

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invested in a combo of stocks bonds real estate hedge funds and other things, such

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that it gets about 7.2 percent a year return with a relatively safe portfolio.

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so then if Kathy clueless invested 100 grand at age 52 ie handed over that [annuity math explained]

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hundred grand to the insurance company so it's all theirs, yep then when we

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divide that 7.2 into 72 and it's 10 meaning it takes 10 years

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for that money to double. so it'll double by the time Cathy's 62 ,that hundred

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grand goes to 200 grand when she's 62, and it still has another decade of

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compounding before she even touches. it so let's do another rule of 72 doubling,

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with that 7.2 thing in yeah that 200k has compounded again to double and be

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worth 400 grand to the insurance company by the time Kathy is 72 and then begins

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to withdraw cash, well to keep the math simpler let's forget the monthly numbers [ATM machine spits out money]

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and just note that she takes out $12,000 a year now right? well that's 12 months

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times a grand a month and well that 400 grand continues to compound again it's

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7.2 percent. that is it grows in value in year 1 at about 29 grand. and the

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insurance company only has to pay Kathy clueless $12,000 a year, so at the end of

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year 1 her account is worth 429 K minus 12 K or about 417,000$. that is even

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with a grand a month payout her account value grew and with compounding each

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year it will grow more than it did the year before and she'll be withdrawing

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way less money than the principal will have grown. if she lives to a hundred

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fifteen the insurance company will still have done well because in this

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particular policy they keep the money at the end.

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now some policies have a life insurance kicker like had she died before she was

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72 her grandkids would get a half a million dollar payout, or her original

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hundred grand would be distributed to her heirs ,or the save-the-whales

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foundation, or something like that. or there'd be some other twist and turn

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that makes the annuity complex and hard to figure out from a mathematics

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perspective for non professionals and the insurance biz. adding to the friction [woman is lost driving down the road]

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is the fact that there are usually very high commissions and fees charged to

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people like Cathy clueless. note her last name there. and they don't realize that

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if they had just been disciplined and put that original hundred grand in an

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index fund and forgotten about it well, they'd have come out vastly better than

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buying that annuity. so why do people buy annuities in the first place? well why

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did people invest in Enron and bad real estate in places and you know some

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people just aren't financially literate enough to make wise decisions about

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their future and they end up investing for retirement in an inefficient vehicle

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like an annuity and you know talk about bad fuel economy and stuff like that. [ car smokes as it is driven]

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they have good brokers though who really know how to make a commission selling

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him maybe they should have watched this video right?

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