How life annuity insurance works

We explain the details of this type of insurance to you
Among the savings and investment products intended for maintaining retired workers' living standards are the so-called lifetime annuity insurance policies. With this type of insurance, the policyholder is guaranteed to receive a periodic income until their death. Moreover, annuities have some interesting tax advantages that we will go over together as part of how this type of savings instrument works.
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How life annuity insurance works

Upon taking out a lifetime annuity insurance, the payment of a single capital contribution (single premium) or of several contributions (extraordinary premiums) is established, depending on the type of insurance and on the insurance company that offers it. Following this payment, the policyholder is guaranteed coverage until their death.

  • Lifetime annuity: the policyholder will receive a monthly, quarterly or annual lifelong periodic income - the amount of which will depend on the total capital contributed by the policyholder, as well as on the yields of the insurance itself. In this respect, the insurance policy managers typically invest the capital contributed in fixed-income, public debt bonds. Moreover, this amount may be increased each year if the client so wishes, or it may remain unaltered until their death.

There are different types and options that the policyholder can take out in relation to their heirs.

There are different types and options that the policyholder can take out in relation to their heirs.

  • Death benefit: If it is established in the contract, in the event of the policyholder's death, an amount can be left that their heirs would receive. This amount can be received by the heirs in a lump sum payment and, usually, it is set as a percentage of the premium contributed.
  • Reversion of the income: Another type is whereby if the policyholder dies, and if it is established in the contract, then a beneficiary would receive the same income as the policyholder or a percentage of that income.

There is, therefore, a wide variety of lifetime annuity insurance policies as the policyholder can decide to take out an annuity with or without capital upon death and with or without reversion of the income.

The amount of the lifetime annuity and the payment to the designated beneficiaries come from the capital contributed by the policyholder, as well as from any yield that this capital has generated. This way, the customer can choose to receive a higher periodic income to the detriment of the capital that their beneficiaries will receive, or to reduce their lifetime annuity in order to ensure a larger payment for their beneficiaries after their death.

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The taxation of lifetime annuity insurance policies

Among the particularities of lifetime annuity insurance policies is the fact that the capital contributed, insofar as the portion assigned as capital for the beneficiaries upon death, is always available to be redeemed by the policyholder, unlike with other savings instruments such as pension plans. The value of the redemption right will depend on the market value of the assigned assets, hence cancellation of the product could result in the policyholder recovering a lower amount than that initially contributed. Therefore, although this is a possibility offered by the product, it is recommended to not consider it an attribute of the product since it entails the possibility of having to assume a divestment cost, as well as having to settle tax charges with the tax authorities. It is therefore essential to respect the life-long nature of the income in these insurance policies.

Moreover, lifetime annuities offer significant tax deductions at the time of receiving the benefit, which can reach up to 92% of the income.

The periodic incomes that the policyholder receives are considered capital gains, for tax purposes. Depending on the customer's age, these incomes received will be taxed at a variable rate as indicated below:

Customer's age % of capital taxed Effective rate that applies
Customer's age
50 - 59 years old
% of capital taxed
28%
Effective rate that applies
5.32%
Customer's age
60 - 65 years old
% of capital taxed
24%
Effective rate that applies
4.56%
Customer's age
66 - 69 years old
% of capital taxed
20%
Effective rate that applies
3.80%
Customer's age
70 years old or over
% of capital taxed
8%
Effective rate that applies
1.52%
It is important to note that if the policyholder cancels the insurance, the resulting redemption of the capital no longer has the aforementioned tax benefits.
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