A basic life annuity makes payments when the annuity owner is alive.
In this sense, an annuity is the reverse of life insurance. Life insurance payments are made when the contract owner passes away. Annuity payments are made while the annuity owner is alive, and annuity pricing is based on the odds of someone being around to receive those payments.
The fact that life insurance becomes more expensive as we age and get statistically closer to death is intuitive. As the likelihood of receiving a life insurance payout increases with age, so does the cost of that life insurance.
The question of when is the best time to lock-in an annuity also boils-down to the probability of receiving payments from the insurance company. Similar to the life insurance example, the annuity is “cheapest” when the statistical likelihood of receiving a payout is lowest.
Consider, for example, a deferred life annuity which has payments that begin at some future date. Assume that annuity payments begin when the owner reaches age 65. Is it cheaper for someone buy this deferred life annuity when they are 43, or is it cheaper when they are 62?
The odds of the 62 year old person surviving to receive annuity payments at age 65 are actually better than the odds for the 43 year old. Life expectancy actually increases as we age.
As a result, the annuity is cheaper for the 43 year old and this younger person is able to leverage their mortality by buying when the odds are in their favor. The “odds in favor” aspect may seem a bit twisted in this case since the odds involve the likelihood of dying before receiving any benefit from the annuity.
The real potential payoff is available to the 43 year old who is in very good health and has a longevity streak in their family genes. This person would be able to lock-in the relatively cheap annuity at a young age before their genetic good fortune is apparent.
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Adrian Wright replied on Permalink
Thanks
Good pension info there thanks