Investment Considerations

Annuity Investment Considerations

Because immediate annuities generally give a series of guaranteed payments, they are priced consistently with other guaranteed investments, such as government bonds. These are less risky than other investments, such as the stock market, and offer a lower expected return. Sometimes annuities are based on investments expected to give a better return, and the risk of these may vary from funds that incorporate some form of protection (for example by purchasing derivatives) through to pure equity funds based on shares alone. At the riskiest end of the market where the fund is not held in trust, the annuity provider risks going bankrupt and possibly defaulting on the policy, as happened in Japan in the 1990s.

Actuarial Considerations

A collection of algebraic shortcuts known as annuity functions are used to model annuities, as well as a variety of other financial arrangements.

Taxation

In the USA tax code, the growth of the premium during the accumulation phase is not subject to current income tax. This is referred to as being tax deferred. Perhaps the tax deferred status of deferred annuities has led to their common usage in the United States. Under the US tax code, the benefits from annuity contracts do not always have to be taken in the form of a fixed stream of payments (annuitization), and many of the contracts are bought primarily for the tax benefits rather than to get a fixed stream of income.

In the United Kingdom, the income from Compulsory Purchase Annuties purchased with pension funds or by an employer immediately on retirement (a 'Hancock annuity) is treated as taxable income. The income from Purchased Life Annuities, bought by any other means, has an element which is considered return of capital, and only the excess over this is considered a gain that is subject to income tax. The element considered capital return is based on life expectancy and will therefore increase with age.

Further Information

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