Annuities
The core function
An annuity is the opposite of life insurance: it liquidates an estate by converting a lump sum into a stream of income that cannot be outlived. The two phases are accumulation (premiums grow tax deferred) and annuitization (payout). A deferred annuity has an accumulation period; an immediate annuity begins payments within about a month of purchase.
Types
Fixed annuities guarantee a minimum interest rate and a fixed payment, with the insurer bearing the investment risk. Variable annuities invest in separate-account subaccounts, require a securities license and a prospectus, and shift investment risk to the owner; payouts fluctuate with performance. Indexed annuities credit interest based on an external index with a cap and floor. Equity-indexed designs typically apply a participation rate and exclude dividends.
Accumulation and annuity units
During accumulation the contract has accumulation units (or a fixed account value). At annuitization, the value converts to annuity units whose payout is fixed in number but whose dollar value changes - under a variable annuity the number of annuity units stays constant while the unit value moves with the subaccounts. Surrender charges apply to early withdrawals, and a market value adjustment may apply to fixed indexed products. Many contracts allow a free withdrawal of about 10% per year.
Payout options and settlement
Life only pays the highest income but ends at death with nothing to a beneficiary. Life with period certain guarantees payments for a set minimum period. Refund life (installment or cash) guarantees that at least the purchase price is returned. Joint and survivor continues income to a surviving joint annuitant, often at a reduced percentage.
Rule of thumb
Want the largest monthly check for a single person with no beneficiaries? Life only. Want a guarantee that premiums come back? Refund or period certain - but expect a smaller monthly payment.