Guaranteed Income Contracts: Everything You Need to Know
The GIC is an agreement between an insurance company and a contract purchaser. 3 min read
2. Types of Guaranteed Income
3. Benefits of Guaranteed Income
4. Drawbacks of Guaranteed Income
Guaranteed income contracts are also referred to as guaranteed investment contracts (GIC). The GIC is an agreement between an insurance company and a contract purchaser. For its part, a guaranteed rate of return is provided by the insurance company in return for holding a deposit for a specified fixed period.
A guaranteed investment contract is usually issued by an insurance company, which usually focuses its marketing to institutions that are qualified under federal laws for favorable tax status.
Information About Guaranteed Income
Payments may be received from guaranteed income as a lump sum after retirement or in installments.
Investments in a GIC are possible using a salary reduction plan, including a 403(b) or 401(k) if your employer offers the investment option. A penalty may be incurred if you choose to change from a GIC to another type of investment.
The insurance company takes a risk when offering a GIC. The goal is to earn more on the investment versus the rate that has been guaranteed on the GIC.
Insurance companies are a general account that combines money with the funds of other general account GIC customers. General account GICs typically have a better return than savings accounts. This is due to their not requiring collateral, nor do they rely on an issuer's creditworthiness. General accounts are considered a relatively safe investment.
The difference between a general account and a separate account GIC is that:
- Underlying assets are kept in separate accounts.
- They're managed by the issuer.
If an insurance company were to mismanage its funds or to declare bankruptcy, companies will be in a position of not receiving the return they contracted for nor the original principal.
Types of Guaranteed Income
- An annuity is one type of guaranteed income product. An annuity is a product where once an initial investment is made, the individual will receive a guaranteed income stream for the remainder of his or her life.
- An annuity can be either variable- or fixed-rate.
- Fixed-rate annuities guarantee a level of income for the term of the annuity. With an annuity, there is no risk of the cash flow decreasing. But inflation can take a toll by gradually depleting the value of the income stream.
- Variable-rate annuities are influenced by the performance of an investment portfolio. This means income levels may fluctuate or even decline. But variable-rate annuities are in a better position to keep pace with inflation.
- The second type of guaranteed income product is the reverse mortgage. With this option, a homeowner receives monthly payments from the lender who provided the reverse mortgage.
- The monthly payments will be issued for the remainder of the individual's life.
- At the time of the homeowner's death, the money received by the homeowner must be paid back to the lender by the estate. If this does not happen, the lender takes possession of the house.
Benefits of Guaranteed Income
There are several benefits to a guaranteed income:
- They are similar to a pension plan in that they provide consistent monthly income payments to retirees.
- These products remove the possibility of an individual outliving their assets.
- It makes budgeting easier and simpler because an individual knows in advance how much he or she will be receiving. Furthermore, the amount isn't dependent on the financial market's fluctuations.
- Retirees are protected from market declines that could negatively affect their portfolio and their standard of living.
Drawbacks of Guaranteed Income
A guaranteed income may prove to have drawbacks for some people, as:
- An individual is locked into a low rate of return. If he or she were to buy a bond or a diversified stock portfolio versus an annuity, the growth potential over time will most likely provide a higher income level than that of an annuity.
- An individual is trading peace of mind of having a guaranteed income over the possibility of earning higher returns.
- There may be high hidden costs with guaranteed income products that are not readily apparent.
- Once an individual has decided to invest in a GIC, it may not be possible to reverse the decision.
- GICs may not be able to compete with the rate of inflation.
- A guaranteed income product may not be the best option for an individual who is considering to leave a bequest to his or her heirs.
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