For retirees who don’t wish to take any market risk, one of the most straightforward retirement income strategies is to simply purchase a bond ladder that will provide the desired cash flows in each year of retirement. Ideally, the payments are secured out to an advanced age, “just in case” the retiree lives that long… with the obvious caveat that if the retiree doesn’t actually live that long, there will be a lot of money left over that “could have” been spent but wasn’t. But that’s simply the risk of an “unknown” retirement time horizon.
In the case of a (lifetime) annuity, on the other hand, the time horizon is known, at least in the aggregate – because with enough people, the mortality rate actually becomes highly predictable, even if it isn’t known exactly which people will pass away from one year to the next. Yet by knowing that at least some people will die each year, an annuity can pay out a portion of the funds that will have been left behind by those decedents, effectively providing larger guaranteed payments for the group than any one individual could have generated on his/her own.
These “excess” payments are known as “mortality credits”, and represent a unique contribution of (lifetime) annuities that simply doesn’t exist with an individual annuity. In fact, the potential for mortality credits means that, for any given maximum potential life span, annuities can actually pay out significantly more than what any individual could enjoy on his/her own, as the contribution of principal and interest and mortality credits will always be greater than the underlying principal and interest alone! Conversely, though, the benefit of mortality credits exists only by virtue of the fact that the other annuitants – and not the annuity owner’s heirs – will benefit from any unused funds that are left over; in fact, trying to protect against an annuity loss in the event of early death, and protect heirs, actually eliminates much of the benefit that annuities are meant to provide in the first place!