This week I will look at annuity — an insurance contract between the owner or annuitant and an insurance company.

In most cases, the owner (person who purchased the annuity) and the annuitant are the same. The annuitant is the person who will receive regular payments from a pension plan or an annuity investment, which generally provides retirement income.

There are various types of annuities. The major ones are the deferred annuity and the immediate annuity. Most pension plans utilise deferred annuities. Regular contributions are made to the pension plans during the working years, and the funds are used to purchase annuities from insurance companies upon retirement. The annuities provide fixed streams of income for retirees for life.

With regards to the immediate annuity, the owner purchases an annuity by making a lump sum payment and in return receives regular income payouts for a specified period or the lifetime of the owner. The income payments begin immediately.

Some retirees received lump sums as their pension payout instead of monthly pension income. Some of these retirees opt to purchase annuities that will provide them with monthly income for as long as they live. Recently, I interviewed one of my clients who retired a year ago. She received a lump sum nearing six million dollars for her pension. The retiree purchased an immediate annuity with five million dollars and invested the remainder. Her pension income from the immediate annuity is $40,000 per month. This client is aware that this sum will remain fixed for the duration of her lifetime. This particular annuity has a guaranteed term of 10 years. Should she die within the first 10 years, her beneficiary will receive the monthly payouts, but these payouts will stop at the end of the 10 years. Every annuity contract has its terms and conditions. Retirees who receive lump sum payouts on retirement oftentimes struggle to decide how to invest the funds to meet immediate and future income needs. Purchasing, an annuity, however, requires careful consideration. What may appear to be a windfall can be gone with the wind in no time. Choosing the right investment vehicle is important and is dependent on the age of the client, their risk profile, and financial goals. The aforementioned client wisely invested a portion of her lump sum by converting the funds to US dollars and investing in a pooled/managed fund of stocks for the long term. Though debt free, and her mortgage is paid off, she is aware that a monthly pension of $40,000 per month will not be sufficient to beat inflation in the future. With a diversification strategy in place and adequate funds invested in short-term instruments to supplement her pension during retirement, this retiree is well on her way to making her retirement years more comfortable.

Early contributions to a workplace pension plan or an approved retirement plan give investors and employees a better advantage in securing retirement income. Funds have a longer time to be invested and retirement payout can be substantial. I encourage pension contributors to maximise pension contributions. The pension law allows a maximum contribution of 20 per cent to a pension plan. Some employers will match employees’ contributions up to 10 per cent. Pension funds invested wisely can earn returns above inflation, thereby giving adequate retirement income.

My recommendation to employees is to invest long term to supplement their pension plans. There is no crystal ball for the future. Retirement income may consist of incomes from different or combinations of sources such as approved pension plans, rental income, real estate investments, stocks, bonds, and business income. Streams of income in retirement should be the ultimate goal.

Annuities provide several benefits upon retirement. Based on Jamaica’s pension law, a pensioner has the option of taking 25 per cent of his/her pension, tax-free, and using the remainder to purchase an annuity which will provide an income for life for the pensioner. Another choice is to use all the accumulated pension funds to purchase an annuity that will provide regular monthly income for life. This option gives retirees a higher monthly pension.Thirdly, there are retirees whose accumulated pension funds are not enough to provide regular monthly income and therefore a single lump sum payout would be necessary. Annuity payouts are determined by age, life expectancy, gender, interest rates applicable, and the amount of money to be invested.

Annuities offer a steady stream of monthly income for retirees and investors. Most annuities offer a death benefit. Annuities have no contribution limits.

Some annuities give survivor benefits which allow monthly payouts to the spouse after the death of the pensioner/annuitant and continue until the death of the spouse/survivor. There are also variable annuities that are suitable for investors with long time horizons. The variable annuities are designed to keep pace with inflation. They are riskier than fixed annuities that offer a fixed stream of income. For many retirees, annuities give them the peace of mind of knowing that they have an income that never stops.

Grace G McLean is financial advisor at BPM Financial Limited. Contact her gmclean@bpmfinancial, and visit the website: www.bpmfinancial.com. She is also a podcaster for Living Above Self. E-mail her at livingaboveself@gmail.com