An Annuity is a purchased policy that pays a fixed amount of benefits every year -- although most annuities actually pay monthly -- for the life of the person who is entitled to those benefits or for a fixed period of time, e.g. 15 years. In a “simple life annuity”, when the person receiving the annuity dies, the benefits stop; there is no final lump sum payment and no provision to keep paying benefits to a spouse or other survivor. A “continuous annuity” pays monthly installments for the life of the retired person, and also provides a smaller continuing annuity payment for the person's spouse or other survivor after the person's death. These annuity contracts are usually with insurance companies and often have high upfront commissions and severe penalties if money is withdrawn earlier than the contract allows.
Common Types of Annuities
- Deferred Annuity- Payment of proceeds is put off (deferred) to a future time, e.g., 5, 10 or 15 years after the money is put into the annuity.
- Immediate Annuity or Income Annuity- A lump sum of money is invested in the annuity and the annuity “immediately” begins paying out a stream of income.
Putting Money into the Annuity - Premiums
- Single Premium- A one-time single cash contribution is made and no further contributions are allowed. Immediate or Income Annuities are always Single Premium.
- Flexible Premium- Multiple contributions at different times are being made into the annuity policy. The contributions will affect how much the policy pays out.
Getting Money Out of an Annuity - Annuitization Options
Annuitization Options are the choices an annuity holder has to receive the annuity value other than in a lump sum. The Annuity Owner chooses how he or she wants the payments to be made. Common annuitization options are:
- Life Only - Payments stop when the annuity owner dies.
- Life With Period Certain – Payments are guaranteed to be made to the annuity owner for as long as he or she lives but if the owner dies before 5 years, 10 years, or whatever agreed upon time period after the annuity had been purchased, then the beneficiaries will be receiving payments until that agreed upon time has lapsed.
- Period Certain – The annuity stops paying out at an agreed upon future date, e.g. 10 or 15 years, even if the annuity owner is still alive.
Rate of Payout and Crediting Methods
- Fixed- Interest rate is declared each year by the company. The interest rates tend to be fairly low, but these products are generally considered the most stable and conservative. Agents selling these products are required to have a Life Insurance License.
- Variable- The amount of payouts is tied to the performance of the investment accounts much like a mutual fund. The client can usually pick among different funds, depending upon his or her risk tolerance. This product requires the insurance agent to have a special license to sell securities.
- Index- The insurance company tags the accumulation value to an index like the S&P 500 or the Forbes 500. The cash value moves up or down in concert with the index. These products are complex and tend to be very difficult for the average person to understand. The interest rate can have a maximum “cap”; there can be a “participation rate”; some have “floors” while others have “thresholds”; and the crediting rate itself can vary, with “point to point”, “annual reset”, and “high water mark” the most common methods. Index Annuities only require the Agent to have a Life Insurance License.
The amount the Beneficiary receives upon death of the annuitant. The important thing to note here is that some annuities reduce the Death Benefit by the Surrender Charge, others do not.
Surrender charges vary greatly from annuity to annuity. Generally speaking, the higher the surrender charge and the longer the surrender period, the higher the commission is to the agent. High surrender charges tend to be a common denominator in abusive annuity sales to seniors.
Page Last Modified:
April 26, 2016