What are the Ramifications of the Life Annuity and its Different Options?Life AnnuityA life or lifetime immediate annuity is used to provide an income for the life of the annuitant similar to a …
What are the Ramifications of the Life Annuity and its Different Options?
A life or lifetime immediate annuity is used to provide an income for the life of the annuitant similar to a defined benefit or pension plan.
A life annuity works somewhat like a loan that is made by the purchaser (contract owner) to the issuing insurance company which pays back the original capital or principal (which isn't taxed) with interest and or gains which is taxed as ordinary income to the annuitant on whose life the annuity is based. The assumed period of the loan is based on the life expectancy of the annuitant. In order to guarantee that the income continues for life, the insurance company relies on a concept called “the law of large numbers.” Because an annuity population can be expected to have a distribution of lifespans around the population’s means (average) age, those dying earlier will give up income to support those living longer whose money would otherwise run out. Thus, it is a form of longevity insurance period.
Life annuity variants
For an additional expense (either by way of an increase in payments (premium) or a decrease in benefits) an annuity or benefit rider can be purchased on another life such as a spouse, family member or friend for the duration of whose life the annuity is wholly or partly guaranteed. For example, it is common to buy an annuity which will continue to pay out to the spouse of the annuity and after death, for as long as the spouse survives. The annuity paid to the spouse is called a reversionary annuity or survivorship annuity. However, if the annuitant is in good health, it may be more advantageous to select the higher payout option on his or her life only and purchase a life insurance policy that would pay income to the survivor.
The pure life annuity can have harsh consequences for the annuitant who dies before recovering his or her investment on the contract. Such a situation called a forfeiture, can be mitigated by the addition of a period-certain feature under which the annuity insurer is required to make annuity payments for at least a certain number of years; if the annuitant outlives the specified period certain, annuity payments continue until the annuitants death and if the annuitant dies before the expiration of the period certain, the annuity estate or beneficiary is entitled to the remaining payment. The tradeoff between the pure life annuity and the life with period certain annuity is that the annuity payment paid by the company for the latter is smaller. Impaired-life annuities for smokers and those with particular illness are also available from some insurance companies.
Thought for the Week
“Old age is like a bank account. You withdraw in later life what you have deposited along the way.”
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