Explain annuities to me

[tannerking1]

I think the two most common annuties are ordinary annuities and annuities due.

https://www.calculator.net/annuity-...cyears=6&printit=0&x=Calculate#annuity-result

I've been using this calculator above as well as using this youtube video...

to get a basic understanding of the math behind annuities.

Starting principal at $1500

Annual Addition of $1500

Monthly Addition of $0

Annual Growth rate of 8%

Policy owner (example) wants it for the next 6 years so...

After *5* years, which confuses me because its like were just skipping the year were on right now.

I calculate that and the ending balance after 5 years is going to be 11k which matches the youtube's video final assessment.

Also I heard that Universal Index Life (IUL) can out perform a Annuity via interest. I need more information on this and need to see the actual match per year.

 

[ativyl]

@tannerking1 The calculator you are using is bad for your purposes. It using "annuity" in the banking sense of a fixed payout scheme not the life insurance sense. For something like a MYGA fund this will work. I do think it is good you are playing with these as a life insurance annuity starts with a banking sense annuity and then adds mortality credits.

In terms of math start with: https://www.investopedia.com/terms/t/timevalueofmoney.asp then https://www.investopedia.com/terms/i/irr.asp . That gets you through the banking concepts. Once that is out of the way then for insurance it jumps up in complexity. For life insurance try just reading something like: https://howshouldithinkabout.com/aging/gompertz-law-of-mortality-from-scratch/

That gets you to pricing term. Combine the two (with the understanding a life insurance annuity is a negative term policy based on NPV of the annuity). There are good textbooks that work through this.

Also I heard that Universal Index Life (IUL) can out perform a Annuity via interest. I need more information on this and need to see the actual match per year.

1. Indexing strategies on average will moderately outperform guarantee strategies.
   
2. An indexed annuity using the same allocation with outperfomr an IUL life insurance policy most times because of much lower fees.
3. An IUL after taxes will outperform the index annuity in (2) despite the higher payouts because of tax advantages generally.

I just wrapped up a series on this.

https://www.reddit.com/r/IncomeInvesting/comments/14j82hw

 

[tannerking1]

@ativyl Huh. I have a lot to read. So when should I give someone a annuity vs a IUL and vice versa?

 

[ativyl]

@tannerking1 This is a good question I may do a post on this. I'd explain both options to start.

Big point: Annuities are a much easier choice for guaranteed depletion. Life insurance a much easier choice for unlikely but possible depletion.

1. Is the money mostly tax advantaged? Annuities can make sense inside tax advantaged accounts, life insurance never will. Let's assume it is not tax advantaged.
2. How rich they are matters. The lower the tax bracket the better annuities will do, the higher their tax bracket the better life insurance will do.
3. How much liquidity vs income matters is the next factor. The more unstable their needs / wants the better life insurance will do. The more expenses are stable the better annuities will do.
4. Assuming the money is not tax advantaged and they are well off I think age is the number two factor. Annuities get terrific when mortality credits get large since they negatively correlate with longevity risk. Also life insurance is much more expensive as one ages. That is at 80 annuities are much better. Life insurance increases longevity risk but can do a terrific job with sequencing risk. So at 60 or lower life insurance will generally be better.
5. Note on the above someone playing it too safe but under 75 has lots of longevity risk and low sequencing risk even though they are younger. Find whatever product you can that they can tolerate to up their return so they decrease their vulnerability to inflation. Insurance company gimmicks can matter to boost someone's risk tolerance.
6. In the other direction don't forget MECs work for people over 60. An insurance policy with negative returns can be drawn from tax free (draw to basis). If they want lots of insurance protection but may need to draw money out later in life a MEC can be a very good structure. For example a 60 year old who wants an expensive disability policy for 8 more years can also have a large tax free bond portfolio inside a MEC as long as the returns from the bonds are less than the disability protection. After the disability insurance is no longer needed it will take time for the MEC to recover to cost basis and that creates a pool of low cost tax free fixed income all through their 70s that can be used for income. After they draw the basis money out it just becomes tax deferred bonds which can be used for emergency expenses taxably or left to heirs tax free on death.

 

[faithfulxlove]

@tannerking1 I’m interested to see what Jeff thinks, but I’d break it into 2 steps. First, whether they need life insurance or an annuity. A lot of factors could come into play, but mainly depends on whether the client wants to spend the money in their lifetime or leave a legacy to a beneficiary. Annuities have death benefit riders but the benefit is generally reduced once it’s annuitized so it may not be sufficient depending on the client’s needs. Once we know if the client needs an annuity or life insurance, the next step could be to determine which type of product. So we can compare either MYGA, indexed, fixed & variable annuity or whole life, IUL, GUL, & VUL. This decision is fairly complicated and may depend on the client’s risk tolerance and market conditions. As Jeff was getting at with his 2nd point: an indexed annuity may be safer than IUL if it has no rider charges. IUL may lapse after its guaranteed no-lapse period ends if the cost of its death benefit/riders exceeds its cash value. However if the goal is to provide a death benefit above the amount of premiums paid, then it would be difficult for an indexed annuity to compete with IUL. Also as in his 3rd point: if the cash value gain is kept in the IUL, then it can grow tax deferred compared with income from the annuity becoming taxable when it is paid.

 

[ativyl]

@faithfulxlove

I’m interested to see what Jeff thinks,

Thanks. Responded to the original here:

https://www.reddit.com/r/LifeInsurance/comments/1bft44y/_/kv56vu2

 

[faithfulxlove]

@tannerking1 The reason the year we’re in is being skipped is because the example in the video is an ordinary annuity with the payments at the end of each year. So although the annuity matures 6 years from today, it only matures 5 years from the date the first payment is made. Just 6 years from today minus the one year until the first payment is made. If it was an annuity due then the first payment would happen today, so 6 years from now the first payment would have been compounded 6 times (assuming annual compounding.)

I’m not sure why you have a starting principle of $1500 with that being different from the example in the video. Unless you’re trying to model an annuity due? If you do want to get the exact same future value as the video, just remove the starting principal since there’s no payment at start of year 1. Then change the calculator mode to ordinary annuity. Leave the rate at 8%. And change the number of years to 6 since the calculator will already skip the first year from being told it’s an ordinary annuity.

Alternatively, you could get the same future value by keeping the $1500 starting principal and reducing the years to 5, because starting principal goes in start of year 1 so waiting 5 years would be equivalent to starting at end of year 1 and waiting to year 6. 6-1=5-0=5

 

[tannerking1]

@faithfulxlove Thank you I have a lot to study