Life annuities are financial products designed to provide predetermined periodic payouts to the annuity owner, known as the annuitant, until their death. People typically fund these annuities through periodic payments while still working, or by making a single large lump-sum purchase, usually at retirement. Life annuities ensure a guaranteed and potentially supplemental source of retirement income that one cannot outlive.
Key Takeaways
- A life annuity offers guaranteed periodic payouts until the annuitant’s death.
- Payments can be made periodically while working or as a lump-sum at retirement.
- Life annuities support retirement by providing or supplementing income.
- Payouts are often monthly, but can also be quarterly, semi-annual, or annual, based on the annuitant’s needs.
How a Life Annuity Works
Life annuities, sold by insurance companies, offer regular fixed payments—either monthly, quarterly, annually, or semi-annually—acting as longevity insurance by passing the risk of outliving savings onto the issuer. Life annuities have two phases:
- Accumulation Phase/Deferral Stage: During this period, the buyer funds their annuity via premiums or a lump-sum payment.
- Distribution/Annuitization Phase: The insurance company starts making regular payments to the annuitant.
Once an annuity is enacted, it provides a reliable income source. Payments stop upon the annuitant’s death or specific triggering events. However, payments can continue to an annuitant’s estate or named beneficiary if a rider or other option is purchased. Since most payouts stop after death, purchasing an additional rider ensures beneficiaries continue receiving payments.
Life annuities sometimes suffer from not being indexed to inflation, thereby possibly losing purchasing power over time. Moreover, they are generally irrevocable once established.
Special Considerations
Consulting a financial expert before purchasing an annuity is vital due to the product’s complexity and significant impact on an individual’s standard of living. Annuities have tax-advantaged benefits, often attracting high-income investors who seek to manage their annual income or transfer large sums efficiently.
Life annuities are also utilized as payment methods for structured settlements and lottery winners. For instance, lawsuit claimants may receive fixed regular benefits, and lottery jackpot winners can choose regular annuity payments over lump-sum alternatives.
Types of Annuities
Different life annuities cater to various needs and benefits:
Immediate Annuity
This annuity type, including payout or income annuities, offers only the distribution phase without the accumulation period.
Guaranteed Annuity
The guaranteed annuity ensures payments for a specific period and continues to distribute to beneficiaries or an estate upon the annuitant’s death.
Fixed Annuity
A fixed annuity pays out a predetermined interest rate on the annuitant’s contributions.
Variable Annuity
Variable annuities provide payouts based on the performance of a selected investment basket or index, offering potential higher returns but also higher risks compared to fixed annuities.
Joint Annuity
This annuity continues payments until the death of both spouses, potentially at a reduced rate after the first spouse’s death.
Qualified Longevity Annuity Contract (QLAC)
A QLAC is a deferred annuity funded by a qualified retirement plan or an individual retirement account (IRA), exempt from IRS required minimum distribution rules. In 2021, individuals could invest up to 25% or $135,000 of their retirement savings in a QLAC.
Related Terms: annuity, retirement plan, insurance product, fixed payment, variable annuity
References
- Mega Millions. “Difference Between Cash Value and Annuity”.
- Internal revenue Service “2021 Limitations Adjusted as Provided in Section 415(d), etc.”, Page 2.
