30 July 2012 0 Comments

Annuity Tutorial (Part 1)

Having meandered into the subject of annuities on my last entry on how to exchange a life insurance policy for an annuity, it’s time for my Annuity Tutorial.

There are basically two types of annuities issued by insurance companies:

  1. Immediate Annuities
  2. Deferred Annuities.

There are three types of investment options from which to select when purchasing an annuity:

  1. Fixed
  2. Fixed with an Index Feature
  3. Variable

First, I’ll concentrate on the Annuity types:

Immediate Annuity

You pay a single premium to the insurance company and receive a guaranteed payment (or in the case of a Variable Annuity, a guaranteed number of units) spread over a predetermined period of time.  You may elect to receive the payments monthly, quarterly, semi- annually or annually.

At the time the annuity is purchased you select the time frame over which the payments are to be received.  This may be a stipulated period of time, such as ten or twenty years, or it may be over the lifetime of the annuitant.  If a lifetime option is elected you have a choice of a payment that will be paid for:

  1. Life Only
  2. Life with Period Certain
  3. Life with Installment Refund
  4. Life with Cash Refund.

The Life Only option produces the largest current income, but all payments stop at the death of the annuitant.  Thus, if the annuitant dies shortly after purchasing the Immediate Annuity, very little of the premium paid to the insurance company will be returned.  On the other hand, if the annuitant lives beyond normal life expectancy much more will be returned than was paid in. The Life Only and Life with Period Certain options may be applied for two lives so that payments would continue to a spouse (or other co-annuitant) after the death of the first.

In a Life with Period Certain option, if a 120 month certain period was elected and the annuitant dies at the end of the 40th month, the named beneficiary will continue to receive payments for another 80 months.

The Life with Installment Refund and Life with Cash Refund options are similar.  If the annuitant dies before 100% of the premium has been received, with Installment Refund the beneficiary will continue to receive payments until the full premium has been returned. With Cash Refund a lump sum payment is made to the beneficiary when the annuitant dies sufficient to bring the total amount received equal to the premium paid.

Guaranteeing income for the rest of your life no matter how long you live is a unique feature of Fixed Immediate Annuities,

In my next entry I’ll show examples of how options on a Lifetime payout affect the amount received, taxation rules and concerns when considering an Immediate Annuity. 

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