Life Annuity

Annuity Phases

Annuities have Two Distinct Phases:

  • The accumulation phase in which the customer deposits and accumulates money into an account, and ;
  • The distribution phase in which the insurance company makes income payments until the death of the annuitants named in the contract.

AnnuityDuring the accumulation phase, in a regular-payment annuity the buyer (annuitant) makes a series of regular payments or in a single-payment annuity he makes a lump sum paymentto the issuer.  At the end of the accumulation phase the distribution phase begins and the issuing insurance companymakes a series of payments to the annuitant for the remainder of the annuitant’s life.

Because the payment stream to the annuitant has an unknown duration, the issuer bases the payment amount upon actuarial tables. Thus a life annuity is a form of longevity insurance, where the uncertainty of an individual’s lifespan is transferred from the individual to the insurer, which reduces its own uncertainty by pooling many clients.

If the accumulation phase consistsof a single  lump sum payment and the distribution phase begins immediately, such a contract is called an immediate annuity. If the distribution takes place at a later date they are called deferred annuities capital grows by investment returns with no more customer deposits.

Types of life annuity

Fixed annuities make payments in fixed amounts or in amounts that increase by a fixed percentage are called fixed annuities.

Variable annuities  pay amounts that vary according to the investment performance of a specified set of investments, typically bond and equity mutual funds. Money deposited into a variable annuity grows on a tax-deferred basis, so taxes on investment gains are not due until a withdrawal is made.

Joint annuities allow payments continue upon the death of one of the annuitants. For example, an annuity may be structured to make payments to a married couple, such payments ceasing on the death of the second spouse.

Impaired life annuities provide a greater payment once a severe enough medical diagnosis of a reduced life expectancy.

Guaranteed annuities insure that the annuity issuer will make annuity payments for at least a certain number of years (the “period certain“); if the annuitant outlives the specified period certain, annuity payments then continue until the annuitant’s death, and if the annuitant dies before the expiration of the period certain, the annuitant’s estate or beneficiary is entitled to collect the remaining payments certain. The tradeoff between the pure life annuity and the life-with-period-certain annuity is that in exchange for the reduced risk of loss, the annuity payments for the latter will be smaller.

Choosing the best annuity plan is an individual choice, what is best for one person may not be appropriate for another. Annuities have the major advantage of providing a guaranteed income for life. It has the disadvantage of paying a fixed rate of return which in times of inflation can be fairly small. But on the other hand it is not subject to the volatility of the stock market so it can provide a good balance to a retirement plan.

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