Lifetime Annuities Explained
Lifetime annuities are the oldest and simplest forms of annuity product in the insurance industry. There is reason they are still around. They work in many, many financial planning situations. The lifetime annuity was originally developed back in the 1800’s to make the retiree’s sunset years secure.
Definition of a Lifetime Annuity
The lifetime annuity is defined by its name. This annuity is an amount payable periodically, usually monthly, for the life of the annuity contract owner. The definition and any modern day derivatives of the name, all apply to the payout period. This annuity may have other payout options such as being paid for the joint lives of the owner and his or her spouse. The annuity may also have some riders attached to the contract such as a minimum amount that will be paid out over the life of the annuity, or a death benefit payable at the end, or the amount of each payment may change periodically. These are all offshoots of the basic annuity which is paid for the life of the contract owner.
Types of Lifetime Annuity Payouts
The original and still most basic payout type of lifetime annuity is the straight life annuity or life only annuity or single life annuity. The annuity is paid periodically for the life of the contact owner and all payments cease at the owner’s death. No death benefit is payable and no continuing payments to a beneficiary. If the annuitant begins to receive payments on June 1 and dies on June 2, all payments cease after the first payment, and the contract is terminated. On the other hand, if a 55 year old starts to receive monthly payments and lives to age 120, the insurance company will make payments until the annuitant is age 120. This type of annuity is simple, clean, and very useful as part of an overall financial retirement plan.
Other types or offshoots of annuity payout options are:
Joint and Survivor Option – periodic payments are made first to the primary annuity owner, and if he or she dies, payments continue to the spouse, if alive, for the remainder of the spouse’s life. The annuity owner may elect up front that 100% or 50% or any amount in between will be continued to the spouse upon the owner’s death.
Term Certain Option – the payments are made for life, with payments made for a minimum number of years as elected by the annuity owner. Most common are 5, 10 and 20 year minimum payment periods. If the annuity owner chose a 10 year Certain, and died after receiving benefits for 7 years, his beneficiary would continue to receive payments for 3 more years.
Installment Refund Option – payments for life and if owner dies, payments will continue to beneficiary at least until the original purchase amount has been paid out
Various combination’s of the above options are available. For example, an annuity owner may purchase a 50% joint and survivor option with a 10 year term certain period. In this annuity, payments are made to the owner, and if he dies, the spouse receives 50% of the former monthly payments. If the spouse should die before the 10th anniversary of the original payment start date, the 50% payments would then continue to a contingent (2nd) beneficiary or, if none, the spouse’s estate.
The decision of what payout options to include in the contract depend upon the owner’s objectives, and cost of each option. The options are paid for by the insurance company issuing a reduced monthly payment. When a person contacts an insurance agent to buy an annuity, the agent will have a proposal done which will show all the available payout options, and how much of payment reduction each option will cost.
How and When Does a Lifetime Annuity get Purchased
Lifetime annuities come on either an immediate or deferred basis. An immediate annuity is purchased with a lump sum contribution and periodic payments to the owner begin immediately. A deferred annuity may be purchase in a lump sum with payments to the owner starting sometime in the future or the purchase price may be paid in over a period of time. For example, the most common form of deferred annuity is the owner putting in the entire purchase price, say at age 40, and starts to receive payments when he reaches age 65. If the owner desires to pay for the annuity contract over a period of time, the contract can be designed so that he contributes the purchase price over 10 or 20 years. Then he retires and starts to receive his payments.
Why Would I Want to Purchase a Lifetime Annuity
The main reason you would want to consider a lifetime annuity is for security and peace of mind. The annuity provides stable income for life which you can never outlive.
The lifetime annuity, even with a number of payout options is a simple concept. You do not have to manage investments, or be worried about the stock market, or report interest to the IRS.
In calculating our annuity quote, the insurance company assumes that it will earn interest at some rate in the future for the projected life of the contract. These rates are normally based on the interest rate environment in effect when the quote is done. Thus, annuity quotes reflect current market interest rates. Also, interest rates used in the calculations for immediate annuities are generally higher than CD or Treasury rates.
The tax treatment allows you to defer tax on earnings under a deferred annuity. You will pay tax on the earnings when you begin to receive your periodic payments from the contract.
Your money is very safe. The money you contribute to a lifetime annuity is guaranteed by the assets in the general account of insurer and not subject to the fluctuations of financial markets. This guarantee is not as good as an FDIC guarantee in a bank, but it is very strong.
What are the Disadvantages of a Lifetime Annuity
The primary disadvantage is lack of liquidity. Once the annuity payout begins, you can only receive your periodic payments. If you have some type of financial emergency and need to get your hands on the money you put into the contract, you are out of luck. Payments cannot be altered once they have begun. If you need to take money out of a deferred annuity before the payout has begun, you can do this but you may be hit with a penalty charge by the insurer in the early years of the contract, you will have to pay ordinary income tax on the amount of withdrawal, and you may be subject to a 10% tax penalty by the IRS.
Another disadvantage is lack of investment growth. While you get guaranteed payments under the contract, if you invest the contribution amount in a diversified stock mutual fund rather than in the contract, your principle may grow much more than the interest rate assumed in the annuity calculation. Over a long period of time, a stock market investment should outperform an investment in a lifetime annuity contract. Of course, with the stock market, there are no guarantees.
What to Choose
No financial planner would ever recommend that all assets be placed in one type of investment vehicle, be the stock market, a bank, a lifetime annuity contract. However, there is definitely a place in your financial plan for a lifetime annuity. Having a guaranteed monthly income creates a good base and cushion for the other investments you may wish to make elsewhere.