An Overview of Annuity Principles and Concepts
Annuity Principles and Concepts
An annuity is a contract that provides income for a specified period of years, or for life. An annuity protects individuals against outliving their money. Annuities are not life insurance, but rather a vehicle for the accumulation of money and the liquidation of an estate. Annuities are marketed by life insurance companies. Licensed life insurance agents are authorized to sell some types of annuities.
Annuities do not pay a face amount upon the death of the annuitant. In fact, they do just the opposite. In most cases, the payments stop upon the death of the annuitant. Annuities use mortality tables, but these tables reflect a longer life expectancy than the mortality tables used for life insurance. Mortality tables indicate the number of individuals within a specified group (e.g., males, females, smokers, nonsmokers) starting at a certain age, who are expected to be alive at a succeeding age.
Owner, Annuitant and Beneficiary
Owner – The purchaser of the annuity contract, but not necessarily the one who receives the benefits. The owner of the annuity has all of the rights, such as naming the beneficiary and surrendering the annuity. The owner of an annuity may be a corporation, trust, or other legal entity.
Annuitant – The person who receives benefits or payments from the annuity, whose life expectancy is taken into consideration, and for whom the annuity is written. The annuitant and the contract owner do not need to be the same person, but most often are. A corporation, trust or other legal entity may own an annuity, but the annuitant must be a natural person.
Beneficiary – The person who receives annuity assets (either the amount paid into the annuity or the cash value, whichever is greater) if the annuitant dies during the accumulation period, or to whom the balance of annuity benefits is paid out.
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Accumulation Period vs. Annuity Period
The accumulation period, also known as the pay-in period, is the period of time over which the owner makes payments (premiums) into an annuity. Furthermore, it is the period of time during which the payments earn interest on a tax-deferred basis.
The annuity period, also known as the annuitization period, liquidation period, or pay-out period, is the time during which the sum that has been accumulated during the accumulation period is converted into a stream of income payments to the annuitant. The annuity period may last for the lifetime of the annuitant or for a specified period, which could be longer or shorter. The annuitization date is the time when the annuity benefit payouts begin (trigger for benefits).
The annuity income amount is based upon the following:
- The amount of premium paid or cash value accumulated;
- The frequency of the payment;
- The interest rate; and
- The annuitant’s age and gender.
An annuitant whose life expectancy is longer will have smaller income installments. For example, all other factors being equal, a 65-year-old male will have higher annuity income payments than a 45-year-old male (because he is younger), or than a 65-year-old female (because women statistically have a longer life expectancy).
If an annuitant dies during the accumulation period, the insurer is obligated to return to the beneficiary either the cash value or the total premiums paid, whichever is greater. If a beneficiary is not named, the death benefit will be paid to the annuitant’s estate.
Insurance Aspects of Annuities
Annuities are not life insurance; they do not pay a face amount upon the death of the annuitant. In fact, they are just the opposite. In most cases, the payment phase stops upon the death of the annuitant. Annuities do use a mortality table, but this table reflects a longer life expectancy than the table used in life insurance. A deferred annuity does grow tax-deferred.
Annuities can be classified according to how premiums are paid into the annuity, how premiums are invested, and when and how benefits are paid out.
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