Different Types of Life Annuities
There are several kinds of life annuities, and they differ by the insurance components they offer. 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 there are, 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 they 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. Therefore, the more insurance components you have, the more expensive your 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 the various types of life annuities more closely.
Straight Life Annuities
These 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 until the annuitant dies. Because there is no other type of insurance component to 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.
Substandard Health Annuities
These are straight life annuities that may be purchased by someone with a serious health problem. They are priced according to the chances of the annuitant dying in the near term. The lower the life expectancy, the more expensive the annuity because there is less of a chance for the insurance company to make a return on the money the annuitant invests.
For this reason the annuitant of a substandard health annuity also receives a lower percentage of his or her original investment in the annuity. However, because life expectancy is lower, the payouts per period are substantially increased compared with the payments made to any annuitant who is expected to live for many years. Other insurance components are generally not offered with these vehicles
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Life Annuities with a Guaranteed Term
Life annuities with a guaranteed term offer more of an insurance component than straight life annuities by allowing the annuitant to designate a beneficiary. If the annuitant dies before a period of time (the term) has passed, the beneficiary will receive the sum of the money not paid out. In the event of an earlier-than-expected death, however, annuitants do not forfeit their 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 in which they receive the payment. These tax implications can result in the annuitant leaving less to his or her designated beneficiaries than intended.
Joint Life with Survivor Annuity
These continue payments to the annuitant’s spouse after his or her death. The payments are passed on no matter what (that is, they don’t depend on whether the annuitant dies before a certain term). These annuities also provide the annuitant the chance to designate additional beneficiaries to receive payments in the event of the spouse’s sooner-than-expected death. Annuitants may state that beneficiaries are to receive lower payments.
The advantages of a joint life with last survivor annuity is that the annuitant’s spouse has the security of continued income after the annuitant’s passing. But because the payments are periodic rather than lump sum, the spouse will not be left with unnecessary tax burdens. The disadvantage here is cost. As these contain more of an added insurance component, the costs to annuitants are substantially higher.
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, 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 fewer 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. Term certain annuities are often sold to people who want stable income for their retirement but are not interested in buying any sort of insurance component or cannot afford one
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