Funding Method
MR. WATSON: There are three funding methods:
- Single Payment - This is obviously one big lump-sum payment, which typically is seen with older annuitants as opposed to younger annuitants.
- Flexible Premium - A flexible premium allows the annuitant to make payments whenever they want for whatever amount they want, and this is more common with younger annuitants.
- Periodic Premium - This is a pretty cool option. It's used when an annuitant has an automatic bank draft fund the annuity, and can be changed back to a flexible premium if the annuitant can no longer commit to the consistent bank draft. But if you keep the bank draft going that means the money is automatically going into the annuity so you don't have to worry about having the discipline to put the money aside.
Date Income Payments Begin
MR. WATSON: There are only two phases to an annuity,
- the accumulation period and
- the annuity period.
During the accumulation period the annuitant is making payments to the company, during the annuity period the company is making payments to the annuitant. An annuity can't do both at the same time, and if you think about it, that wouldn't make any sense anyway. It would make no sense to have a steady monthly payment coming out of a bucket only to put that money back into that bucket. So the annuity is always either in the accumulation period or the annuity period.
Immediate Annuity
MR. WATSON: Immediate annuities are, of course, funded with a single payment because the annuitant is going to annuitize the money immediately. If a monthly payment is chosen, payments begin one month after the annuity was funded with the single premium; if semi-annual payments are chosen, payments beginning in six months, etc.
Deferred Annuity
MR. WATSON: Since it's called "deferred", that means payments to the annuitant begin later, ya think?
STUDENTS: Sure
MR. WATSON: The date that you plan on annuitizing does not need to be decided at the time of purchase, you decide that whenever you're good and ready. Of course, once annuity is annuitized no further payments can be made into the annuity as we already said.
Payout Options
MR. WATSON: The payout options are decided when the annuitant annuitizes, not when they purchase the annuity. In effect, the annuitant is trading the annuity (the bucket of money) and giving it to the insurance company in exchange for a monthly or annual check which will last for the annuitant's lifetime no matter how long that is. Remember, the insurance company only uses age and sex to determine the payout calculations, NOT HEALTH. Also, the more guarantees the contract holder desires, the less the monthly payment. Likewise, the riskier the payout option is, the higher the monthly payment. Let's go through some payout options again:
Life only (same as Straight Life)
MR. WATSON: Payments stop at death, no matter how soon or long that is. There is no beneficiary for this payout option. This has the highest monthly payout, but that's because it's the riskiest. If the annuitant dies right after they annuitize, all the money is kept by the insurance company. Does this sound familiar from earlier?
STUDENTS: Yes.
Life with Period Certain
MR. WATSON: This option guarantees to pay for the life of the annuitant, or a certain length of time, whichever is LONGER. For example, life with a 20 year period certain will pay for the annuitant's lifetime, even if it's beyond the 20-year guarantee. But, if she should die in year five, the annuity would continue to pay a beneficiary for 15 more years.
Life with refunds
MR. WATSON: This option guarantees 100% payout of the annuity. So if the annuitant dies before the full amount is paid out, the company will pay the balance in cash or installments to a beneficiary. This is the safest option, and so typically has the lowest monthly or annual payout amount of the payout options.
Annuities Certain - (does not pay for lifetime)
MR. WATSON: This is something that's sometimes used by banks and other financial institutions because it doesn't require an actuarial table since it's not paying for the lifetime of the annuitant. It pays a fixed amount - pays a fixed dollar amount every month until the funds are exhausted, and not for the life of the annuitant. The fixed period option pays over a fixed period of time and then the funds are exhausted. If the annuitant dies before the funds are exhausted then the balance is paid to a named beneficiary because this option is meant to pay out the entire annuity.
Partial withdrawals
MR. WATSON: Remember, withdrawals are not the same thing as annuitizing - they are totally different. This is when the annuitant has not annuitized and would like to take an amount out of the annuity. The annuitant can do this as many or as few times and as often as they like, just like going to the ATM, and can either completely surrender the annuity or take random withdrawals. Earnings, which is the interest portion, are taxed as ordinary income in the year the withdrawal is taken out, and an additional 10% penalty tax of the amount taken will be assessed if done before age 59 1/2.