Annuity definitions, parties, and uses

What an annuity does

An annuity is a contract under which an insurer accepts money and promises payments according to the contract. Its central retirement use is turning accumulated money into income. A life income option addresses longevity risk: the risk of outliving your resources. Life insurance primarily addresses the financial consequences of dying; a life annuity addresses the financial consequences of living a long time.

Four roles

The insurer issues the contract and owes its promised benefits. The owner holds contractual rights, such as selecting available options and naming a beneficiary. The annuitant is the person whose life is used to determine life-contingent payments. The beneficiary receives any death benefit or continuing payments provided for that person under the contract. Naming a beneficiary does not itself create a death benefit.

One person can be both owner and annuitant. They can also be different people. For example, Elena owns an annuity based on her husband Marco's life and names their daughter Nina as beneficiary. Elena controls the contract, Marco supplies the measuring life, and Nina receives benefits if the contract provides for her to receive them.

From money to income

During accumulation, money remains in the contract to build value before scheduled annuity income begins. Annuitization converts value into a scheduled payment stream. An immediate annuity begins income soon after purchase; a deferred annuity postpones income. A withdrawal of part of the account is not necessarily annuitization.

Payments may last for a fixed period or for one or more lifetimes. A ten-year period-certain annuity schedules ten years of payments; it does not promise income throughout a longer life. A straight life option continues while the annuitant lives and stops at death. Refund or guaranteed-period features can provide benefits after death, with different payment amounts.

Uses and limits

Annuities can accumulate retirement funds, supplement pension income, and provide scheduled payments for settlement obligations. Income design matters: a fixed payment can lose purchasing power to inflation. Contract terms, charges, liquidity limits, tax rules, and the insurer's ability to pay must be considered before purchase. Federal tax law distinguishes taxable income from recovery of investment in the contract; tax deferral is not tax exemption.

For exam questions, first identify who controls the contract, whose life measures payments, and what payment duration was selected.