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Annuity classification and payout options

Two phases, three roles

Every annuity is a contract with an insurer that turns money into income. It has two phases. During the accumulation phase the owner pays premium and the contract value grows tax-deferred. During the payout (annuitization) phase the insurer converts that value into a stream of payments. Learn the three parties: the owner (pays and controls the contract), the annuitant (the measuring life whose age and sex determine the payment amount), and the beneficiary (receives any death or survivor benefit). Life insurance and annuities are regulated together in Texas under Title 7 of the Insurance Code, Life Insurance and Annuities, chapters 1101 through 1154 (Tex. Ins. Code Title 7).

Classifying an annuity: three questions

  1. How is it funded? A single premium annuity is bought with one lump sum. A flexible or periodic premium annuity is funded with a series of payments over time.
  2. When does income start? An immediate annuity begins paying almost at once after a single premium, so it has essentially no accumulation phase. A deferred annuity accumulates value first and begins income at a later date chosen in the contract.
  3. How does the value grow? A fixed annuity credits interest declared by the insurer, subject to a guaranteed minimum, and the insurer carries the investment risk. An indexed annuity ties crediting to the performance of an external index, usually with a floor and a cap or participation limit. A variable annuity places value in separate-account subaccounts the owner selects, so values and future payments rise and fall with investment results and the owner carries the investment risk.

Any annuity can be described by picking one answer from each of the three questions -- for example, a single premium immediate fixed annuity, or a flexible premium deferred variable annuity.

A one-page map of annuity concepts. Across the top runs a timeline of three boxes connected by arrows: accumulation phase, labeled deferred contracts only, then annuitization, then income payments, labeled payout phase. Below on the left, under the heading Classify by three questions, are three stacked boxes. Box one, how is it funded, lists single premium as one lump sum and flexible or periodic premium. Box two, when does income start, lists immediate with no accumulation period and deferred with income at a future date. Box three, how does value grow, lists fixed with a declared rate and guaranteed minimum, indexed tied to an index with a floor and cap, and variable using separate accounts where the owner carries the investment risk. On the right, under the heading Choose a payout option, are two boxes. The green box, life-contingent, lists straight life or life only which gives the largest payment, life with period certain, life with refund either installment or cash, and joint and survivor covering two annuitants; a note says payments depend on a life still in force. The tan box, not life-contingent, lists period certain for a fixed number of years, fixed amount until the fund is exhausted, and lump sum or surrender with no annuitization. A wide box at the bottom states the key trade-off: the more the insurer guarantees to a survivor or beneficiary, the smaller each income payment. It also notes that the owner pays and controls the contract, the annuitant is the measuring life, and the beneficiary receives survivor or refund benefits, and that life insurance protects against dying too soon while an annuity protects against outliving savings.
Annuities are classified by funding, start date, and crediting method, then paid out through life-contingent or non-life-contingent options.

Payout (settlement) options

Payout options split into those that depend on someone still being alive and those that do not.

Life-contingent options

  • Straight life (life only): income for the annuitant's lifetime and nothing after death. Because nothing is guaranteed to a survivor, this produces the largest periodic payment for a given amount of money.
  • Life with period certain: lifetime income, but if the annuitant dies before a stated number of years has elapsed, payments continue to the beneficiary for the rest of that period.
  • Life with refund (installment or cash refund): lifetime income with a guarantee that at least the amount applied is returned, in installments or as a lump sum, to the beneficiary.
  • Joint and survivor: covers two annuitants; when the first dies, income continues to the survivor, often at a reduced percentage.

Options that are not life-contingent

  • Period certain (fixed period): equal payments for a set number of years, to the annuitant or the beneficiary, regardless of survival.
  • Fixed amount: a chosen payment amount continues until the fund and its interest are exhausted.
  • Lump sum or cash surrender: the owner takes the value instead of annuitizing.

The exam trade-off to remember: the more the insurer guarantees, the smaller each payment.

Contrast with life insurance

Life insurance pays a benefit because someone dies too soon; an annuity protects against living too long and outliving savings (Tex. Dep't of Ins. Consumer Pub. CB018, Life Insurance Guide). Cash-value life insurance carries statutory nonforfeiture guarantees under the Standard Nonforfeiture Law for Life Insurance (Tex. Ins. Code ch. 1105), and the definitions and requirements for life insurance itself sit in chapter 1101 (Tex. Ins. Code ch. 1101).

Sample questions

For a given amount of accumulated value and the same annuitant, which settlement option produces the largest periodic payment?

  • Life income with a 20-year period certain
  • Joint and survivor
  • Life income with installment refund
  • Straight life (life only)
Preview

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