Annuities represent as much misunderstanding as any product or service in the financial services industry. The primary reason is that no two situations are exactly alike, as no two person’s level of risk tolerance and suitability are exactly alike. For this discussion, we would like to focus on different types of annuity settlement options and definitions to try and clear up as much of the maze which clouds today’s landscape.
What is an annuity? An annuity is a method of systematically liquidation of a set sum of money. Annuities may be purchased on either a deferred or immediate basis. A deferred annuity is when a lump sum of money is given to an insurance company and grows until the annuitant decides to remove it, either in a lump sum or in monthly increments. Normally, when a lump sum is annualized, the client exchanges the control of the lump sum for a guarantee that monthly payments will continue for the rest of the annuitant’s life.
What is a life income with no refund option? A life income with no refund option is exactly as it was written. The client will receive a monthly sum for the rest of their life, whether they live 30 days or 30 years. For example, if a 65 year old male gives an insurance company $100,000 under this option, he is guaranteed and income of $….. If he dies the day after receiving the initial payment, the insurance company retains all of the proceeds, and no additional payment to any beneficiary or contingent payee is required. Given the exposure of the insurance company, this option would provide the highest possible income, because even though there is a life income attached, there is no minimum guarantee that payments must be made for a certain period of time. Obviously, this option should only be used in extraordinary circumstance. For instance, if a single individual has no heirs and is not concerned with leaving any money to anyone, and wishes to maximize the amount received, this option would be considered appropriate.
What is a life income with period certain option? A life income with period certain option means that the insurance company will guarantee payments for a particular period of time. For example, if an annuitant accepts a “Life with 10 years certain” guarantee, the annuitant is guaranteed to receive payments for at lest ten years. If they live beyond ten years, payments continue until their demise. If they die within the ten year period, the beneficiary will continue to receive the monthly payments until the ten years has elapsed. This option will provide less income than the life income with no refund option, as the insurance company is GUARANEED to send payments to someone for at least ten years. In the “no refund” example, payments end upon the annuitant’s death, no matter when that may occur. Insurance companies will typically guarantee payments in five year increments up to as much as twenty years. The longer the guarantee, the LESS the amount of monthly income will be payable, as the company has a liability for the longer period of time.
What is life income with refund option? As it states, life income with refund guarantees a return of principle to either the annuitant or their beneficiary. Should the original annuitant die before receiving all of their money back, payments would continue to the beneficiary until all principal has been received. At that time, payments would cease. Should the annuitant live after having received back their principle, the monthly payments would continue as this is a “life” income, first and foremost.
These three examples are showing how a “single life” annuity would work. Also common are joint and survivor annuities which would be out over two lives, a husband and wife for example. We will discuss those options in a later piece.
Guarantees are based on the claims-paying ability at the issuing company.