An annuity is a product that can provide you with a lifetime income, typically on retirement. Annuities are viewed as a way to hedge against longevity risk, or the potential for one to outlive one’s invested assets. Social Security and/or defined pension benefits are prominent examples of annuities.
Annuities can be structured with a variety of different specifications. Given its traditional purpose of providing perpetual cash flow to the beneficiary (also known as the annuitant), it is commonly structured as open for the duration of the annuitant’s life or his or her survivorship beneficiary.
They can also be constructed as providing benefits over a set period of time, such as 25 years. Annuity payouts can also begin at the outset of a lump sum deposit, or can take place at a certain specified point in the future, such as ten years from initial deposit or when the annuitant comes of retirement age.
The payment sum, typically monthly, can also be set up as a fixed or variable structure.
A fixed rate provides the safety of a knowable monthly number. But it also sets up risk in the form of higher inflation reducing its real value or leaving cash on the table in the event the investments perform better than expected.
A variable structure allows for payments to ebb and flow based on returns and can also provide less risk for the issuer (usually a life insurance company) of the product by avoiding getting locked into a fixed payout scheme.
Risks of Annuities
Deposits into annuities entail a lockup period, where funds generally can’t be withdrawn before a specified period. If funds of a certain amount are drawn before the stated period, the annuitant would face a penalty. Lockup periods can be 10 years, or sometimes even longer similar to other illiquid investments such as hedge funds, private equity, and venture capital. The sooner the funds are drawn, the greater the penalty tends to be.
This is instituted by issuers to better ensure that they’ll make a return on investment on these products (otherwise there is no point in them offering the service). Similarly, insurers will add costs to a product that demands earlier payment withdrawals, longer payout durations, accelerated payouts upon the triggering of some clause, risk hedging (e.g., inflation linkage, etc.), survivorship benefits, and other potential features that could conceivably increase the product’s present value of cash flows.
Annuities in Day Trading
Annuities can be a great option for those who want to hedge the risks involved with potentially outliving their saved assets. Day trading is an active form of asset management where traders are generally looking to take advantage of short-term movements in the market.
Even so, it can be beneficial for those with more active, higher-volume trading styles to set aside a portion of their income each month as savings in a longer-term portfolio, potentially in the form of annuity. Developing a nest egg or rainy-day account as a complement to your active trading strategy can work to hedge risks and better secure your financial future.