Fixed Annuity


 

Annuities are a life insurance product which protects against the risk of outliving your income.     

   

Types of Fixed Annuities
The two main types of fixed annuities are life annuities and term certain annuities. Life annuities pay a predetermined amount each period until the death of the annuitant, and term certain annuities pay a predetermined amount each period (usually monthly) until the annuity product expires, which may very well be before the death of the annuitant. 
 

Life Annuities
There are several kinds of life annuities, and they differ by the insurance components they offer the annuitant. That is, certain types of life annuities may alter the future payment structure in the event of something negative happening to the annuitant, such as sickness or early death. More specifically, the more insurance components, the longer the payments may last over time once the annuitization phase begins (we look at how this works below) - and the longer the payments are to last, the smaller the monthly payments will be. The amount of the monthly payments also depends on the life expectancy of the annuitant: The lower the life expectancy, the higher the payment (because more of the annuity investment must be paid out over a shorter period).

Also, the prices of life annuities are composed of the money invested in the annuity but also the premium paid for these insurance components, so the more insurance components, the more expensive the annuity will be. Each type of life annuity has its own advantages and disadvantages, depending on the nature of the annuitant. Let's look at types of life annuities more closely.

Straight life annuities are the simplest form of life annuities - the insurance component is based on nothing but providing income until death. Once the annuitization phase begins, this annuity pays a set amount per period to the annuitant until s/he passes away. Because there is no other type of insurance component of this type of annuity, it is less expensive. Also, straight life annuities offer no form of payout to surviving beneficiaries after the annuitant's death. Those wishing to leave an estate to their survivors would be well advised to keep other investments if they are inclined to purchase a straight life annuity.

A substandard health annuity is a straight life annuity that may be purchased by someone with a serious health problem. These annuities are priced according to the chances of the annuitant's passing away in the near term. The lower the life expectancy, the more expensive the annuity because there is reduced chance for the insurance company to make a return on the money the annuitant invests into the annuity. For this reason, the annuitant of a substandard health annuity also receives a lower percentage of his or her original investment in the annuity. But because his or her life expectancy is lower, the payouts per period are substantially increased compared to the payments made to any annuitant who is expected to live for many years. Other insurance components are generally not offered with these vehicles.

Life annuities with a guaranteed term offer more of an insurance component than straight life annuities by allowing the annuitant to designate a beneficiary. So if the annuitant passes away before a period of time (the term) has passed, the beneficiary will receive the sum of the money not paid out. So in the event of an earlier-than-expected death, annuitants do not forfeit their annuity savings to an insurance company. Of course, this advantage comes at an additional cost.

Another thing to remember with life annuities with a guaranteed term is that in the event of unexpected death, beneficiaries receive one lump-sum payment from the insurance company. The likely result of such a payout is a spike in the annual income of the beneficiaries, and an increase in income taxes in the year they receive the payment. These tax implications can result in the annuitant leaving less to his or her designated beneficiaries than intended.

Term Certain Annuities
These annuities are a very different product than life annuities. Term certain annuities pay a given amount per period up to a specified date, no matter what happens to the annuitant over the course of the term. However, if the annuitant dies before the specified date, the insurance company keeps the remainder of the annuity's value.

These contain no added insurance components; that is, unlike the life annuities discussed above, the term certain annuities do not account for the annuitant's condition, life expectancy or beneficiary. Further, in the event of failing health and increased medical costs, the income of a term certain annuity will not increase to accommodate the annuitant's increased expenses. Because these annuities offer less insurance options and therefore pose no risk to the insurer or financial-services provider, they are substantially less expensive than life annuities.

The disadvantage of these income vehicles is that once the term ends, income from the annuity is finished. Often, term certain annuities are sold to people who are looking for stable income for their retirements but who are not interested in buying any sort of insurance component or cannot afford it.