What is a life annuity?
A life annuity is an insurance product that has a predetermined periodic payment amount until the death of the annuitant. They are commonly used to provide guaranteed retirement income that cannot be survived. Generally, the annuitant periodically pays the annuity while he or she is still working. However, annuitants can also purchase the annuity product in one big purchase, usually retired.
How does a life annuity work
Life annuities, with their guaranteed lifetime payments, are essentially longevity insurance, because the risk of surviving their savings is transferred to the annuity issuer, generally an insurer. Life annuities are often used as a method of payment for lottery winners and in structured settlements. Defined benefit pension plans are a form of life annuity, in the sense that they pay a lifetime benefit based on an employee’s salary, age and length of service.
Once funded and promulgated, the annuity pays the annuitant periodically, usually monthly, a reliable source of income. When a triggering event occurs, such as a death, the periodic payments of the annuity generally cease, although they may continue to pay depending on the option chosen by the annuity buyer.
Although annuities generally pay a benefit every month, they can also be paid quarterly, annually or semi-annually, depending on the annuitant’s needs or tax situation. Many retirees finance a life annuity corresponding to their recurrent housing (mortgage or rent), assistance with independent living, health care, insurance premiums or medical expenses. If a life annuity pays a guaranteed income, it is not indexed to inflation, so that purchasing power can erode over time. A life annuity, once promulgated, is not revocable.
The annuity has two phases: accumulation (or deferral), when the buyer finances an annuity with premiums, and distribution (or annuity), during which the annuitant receives payments until death.
Due to the complex nature of annuity products and their implications for the annuitant’s standard of living, people are advised to consult a reputable professional before purchasing an annuity product. Due to the tax-advantaged nature of annuities, very wealthy or above-average income investors often use these life insurance products to transfer large amounts of money or to mitigate the effects of taxes on their annual income.
Example of an annuity
There are several types of life annuities, each with its own purpose. For example:
Immediate annuity: Only has a distribution phase, as is also the case with a payment annuity, an income annuity or an immediate single premium annuity.
- Guaranteed annuity: pays for a certain period and will continue to pay to a beneficiary or an estate after the death of the annuitant. Also called a certain one-year annuity or a certain period annuity.
- Fixed annuity: pays a fixed percentage.
- Variable annuity: paid according to the performance of a basket of investments or an index.
- Joint annuity: Pay until the death of both spouses, sometimes at a reduced amount after the death of the first spouse.