Choose between annuity income trade-offs

Introduction

When an annuity starts paying income, someone has to decide what happens to the payments when a person dies. That one decision drives everything else in this lesson.

Some payout options stop the moment the annuitant dies. Others keep paying a beneficiary for a while, return part of the premium, or keep paying a second person. Every extra protection after death has a cost. For the same premium, protection after death generally means a smaller payment while the annuitant is alive.

No option is best for everyone. Your job is to read the stopping rule for each option and say what it protects and what it gives up.

What you'll be able to do

• Explain who the annuitant is and why that person's life controls life-based payments.
• Compare life only, period certain, life with period certain, refund and joint and survivor payouts by their stopping rule.
• Calculate the payments left to a beneficiary, a refund amount, and a survivor payment from stated facts.
• Explain why more protection after death usually means less income now, without calling any option the best choice.
• Tell joint and survivor annuity income apart from a life insurance death benefit.

Before you start

This lesson builds on two earlier ideas:

• In Understand annuities as an income tool, you saw that annuitizing turns an annuity's value into a stream of income payments. This lesson covers the choices made at that point.
• In Cover two lives without confusing the payment trigger, you separated the life that triggers a payment from the person who receives it. The same separation matters here.

Every amount, count and percentage in this lesson is fictional and stipulated for teaching. None of them is a real quote or a typical market rate.

The annuitant: whose life sets the clock

Annuitant: the person whose life the payments depend on. In plain terms, the annuitant's life is the clock. For life-based options, payments run while that clock runs.

The annuitant is often also the buyer and the person who receives the checks, but those are separate roles. A beneficiary is the person named to receive any money the option still owes after the annuitant dies. Whether the beneficiary gets anything at all depends entirely on the payout option chosen.

A payout option is the set of rules that says how long payments last and what happens at death. To read any payout option, ask two questions:

1. What ends the payments?
2. If the annuitant dies early, does anything continue?

Option 1: Life only

Life only (also called straight life): payments last for the annuitant's whole life and stop at the annuitant's death. Nothing continues after that.

The connected case (fictional): Dana is the annuitant and chooses monthly income. Under the stipulated quotes, Dana's premium buys:

• Life only: $1,050 per month
• Life with 120 payments certain: $980 per month
• Life with a refund feature: $960 per month

Suppose Dana chooses life only and dies after receiving 40 payments. The payments stop, and the beneficiary receives nothing from the annuity.

This fits the definition because Dana's life was the only clock and that clock stopped. Life only has no built-in promise to anyone else.

Qualification: life only does not automatically refund premium that was "unused." If Dana dies early, most of the premium may never come back as income. That risk is what Dana accepted in exchange for the highest monthly amount in this quote. The upside is that Dana cannot outlive these payments, however long Dana lives.

Option 2: Period certain

Period certain: payments last for a fixed stretch of time, such as 120 monthly payments, and then stop. The annuitant's life does not extend them.

Change one fact. Dana chooses 120 payments certain instead, with no life feature.

• Dana dies after 40 payments. The option still owes 120 − 40 = 80 payments, and the beneficiary receives them.
• Dana is still alive after payment 120. The payments stop anyway. Dana's survival does not add any more.

The count is fixed in advance and is what this option promises. Payments continue past death only because the count isn't finished. They stop at the end because the count is finished.

The tempting mistake: assuming "certain" means "certain for life." Period certain lasts for the period, not for life. Someone who lives much longer than the period can outlive this income.

Option 3: Life with period certain

Life with period certain: payments last for whichever is longer: the annuitant's life or the guaranteed period. It combines the two stopping rules above.

Dana chooses life with 120 payments certain at the stipulated $980 per month.

• Dana dies after 40 payments. The beneficiary receives the 80 remaining guaranteed payments, and then payments stop.
• Dana lives well past payment 120. Payments continue for the rest of Dana's life. After payment 120, the guarantee is used up. When Dana later dies, nothing more is paid.

Two misconceptions show up here:

• "A life with 10-year certain option ends after 10 years." It doesn't. The 10 years is a minimum, not a maximum. If the annuitant outlives the period, payments continue for life.
• "The guaranteed count restarts after death." It doesn't. The beneficiary receives only what's left of the original count. After 40 payments, 80 remain, not a fresh 120.

Comparing the stipulated outcomes

Only life with period certain protects against both an early death and a long life. In this stipulated quote, that protection costs $70 per month compared with life only ($1,050 − $980).

Checkpoint 1

a) An annuitant has life with 240 monthly payments certain and dies after receiving 95 payments. How many payments does the beneficiary receive?

b) A different annuitant has period certain for 240 monthly payments and is alive and healthy after payment 240. What happens next?

Answer: Explanation

a) 145 payments, because 240 − 95 = 145. The beneficiary continues the original count. The count does not restart at 240.

b) Payments stop. A period certain option ends when the period ends, whether or not the annuitant is alive. Had this been life with period certain, payments would continue for life.

Option 4: Life with a refund feature

Refund feature: payments last for the annuitant's life. If the annuitant dies before the total payments received equal the premium paid, the difference goes to the beneficiary, either in cash or in installments.

The two options in the last section counted payments. A refund feature measures dollars.

Back to Dana (fictional): Dana paid a stipulated premium of $180,000 and chose life with a refund feature at $960 per month.

• Dana dies after 100 payments. Total received is 100 × $960 = $96,000. The shortfall is $180,000 − $96,000 = $84,000, which goes to the beneficiary.
• Change one fact: Dana dies after 200 payments. Total received is 200 × $960 = $192,000. That is already more than the $180,000 premium, so there is no shortfall and nothing is refunded.

The refund feature tops up payments to the premium amount if Dana dies early. Once Dana's own payments reach that amount, the promise has been met.

The tempting mistake: treating a refund feature and a guaranteed period as the same thing. Both protect against early death, but they measure different things. A period guarantee asks how many payments are left. A refund asks how many dollars short of the premium the annuitant is. Read which one the contract states before calculating.

Option 5: Joint and survivor

Joint and survivor: there are two annuitants, called joint annuitants. Payments continue as long as either of them is alive and stop when both have died.

Survivor percentage: the share of the original payment that continues after the first annuitant dies. The contract states it. It may be 100%, or a reduced share such as 75%, two-thirds or 50%.

Fictional case: Morgan and Sam are joint annuitants. The stipulated payment is $1,200 per month while both are alive, with a 75% survivor percentage.

• While both are alive: they receive $1,200 per month. Income starts now. It does not wait for anyone to die.
• After the first death: the survivor receives 75% × $1,200 = $900 per month for the rest of the survivor's life.
• After the second death: payments stop.

Change only the survivor percentage:

• At 50%, the survivor receives 0.50 × $1,200 = $600.
• At 100%, the survivor keeps receiving $1,200.

Two misconceptions appear here:

• "The survivor always gets 100%." No. The percentage is a choice written in the contract, and it is often reduced.
• "Joint and survivor income starts only after both die." No. Income is paid while the annuitants are alive. After both deaths, this option has nothing left to pay.

Don't confuse this with life insurance on two lives

A life insurance death benefit is paid because someone died. For example, a second-to-die (last-to-die) life policy pays its death benefit when the last surviving insured dies. Annuity income is paid because the annuitants are alive. The plain life-contingent joint and survivor annuity discussed here pays while either annuitant lives and stops at the last death.

So, for that plain option, the last death has opposite effects. It triggers the second-to-die life insurance payment, and it ends joint and survivor annuity income that has no remaining period-certain, refund or other continuation guarantee. The same contrast applies to one life. A whole life policy pays at the insured's death, while a life only annuity stops paying at the annuitant's death. For a refresher on premiums and permanent coverage, see Understand whole life and premium schedules.

The trade-off: income now versus continuation after death

Look again at Dana's stipulated quotes. For the same premium:

• Life only paid the most each month, at $1,050.
• Adding a 120-payment guarantee lowered it to $980.
• Adding a refund feature lowered it to $960.

This pattern holds in general for comparable quotes. Adding a guaranteed period or a refund feature to a life option lowers the starting payment compared with life only. The insurer is promising to pay in more situations, including after an early death, so each payment is smaller.

That makes the decision a trade-off, not a ranking:

• Life only gives the most income per month. The risk is that an early death leaves much of the premium unpaid, with nothing for anyone else.
• A period or refund guarantee lowers that early-death risk but gives less income every month the annuitant is alive.
• Joint and survivor keeps income going for a second person, but only at the survivor percentage the contract states.

Which trade-off fits depends on facts like whether someone else relies on the income and how much weight the person gives to an early death compared with maximum income. Those facts belong to an individual situation. This lesson teaches you to explain the trade-off, not to recommend a choice for a particular person.

One limit applies to every option. Any guarantee depends on the insurer's financial strength and its ability to pay claims.

Checkpoint 2

A friend says: "Life only is a bad deal, because if you die early the insurer keeps your money. Everyone should pick a refund option." What's wrong with that reasoning?

Answer: Explanation

The friend describes only one outcome. Life only does carry the early-death risk, and it has no automatic refund. But in exchange it pays more per month for the same premium, and that matters most to someone who lives a long time. A refund feature lowers the early-death risk by permanently lowering every payment. Each option gives up something, so neither one is right for everyone.

Practice: four new cases

Work each case on your own before opening its answer. All facts are fictional and stipulated.

Case 1

An annuitant chooses life with 15 years certain, paid monthly, and dies after receiving 60 payments. How many payments does the beneficiary receive, and what happens after those?

Answer: Explanation

Fifteen years of monthly payments is 15 × 12 = 180 payments. The annuitant received 60, so 180 − 60 = 120 payments go to the beneficiary. After those, payments stop, because the guarantee is used up and the annuitant has died.

Case 2

Joint annuitants receive $1,500 per month with a two-thirds survivor percentage. What do they receive this month while both are alive? What does the survivor receive after the first death?

Answer: Explanation

While both are alive, they receive $1,500. Joint and survivor income starts during their lives. After the first death, the survivor receives two-thirds of $1,500, which is $1,000 per month, until the survivor dies. The survivor amount comes from the stated percentage. It is not automatically 100%.

Case 3

An annuitant chooses life only and dies after 8 monthly payments. The beneficiary asks for the rest of the premium back. What does the annuity pay?

Answer: Explanation

Nothing more. Life only stops at the annuitant's death and has no refund or guaranteed period. The beneficiary's request assumes a refund feature this option doesn't include. The higher monthly payment was the trade for accepting this outcome.

Case 4

An annuitant paid a $120,000 premium for life with a refund feature, at $800 per month, and dies after 110 payments. How much does the beneficiary receive? Would the answer change if death came after 160 payments?

Answer: Explanation

After 110 payments, the annuitant received 110 × $800 = $88,000. The shortfall is $120,000 − $88,000 = $32,000, paid to the beneficiary in cash or installments. After 160 payments, the annuitant would have received 160 × $800 = $128,000. That exceeds the premium, so no refund is owed. The refund compares dollars received with premium paid. It does not count remaining payments.

What to remember

• The annuitant's life is the clock for life-based payments. The beneficiary receives money only if the chosen option still owes something at death.
• Life only: guarantees payments for the annuitant's life and stops at death. There is no guaranteed minimum payment period and no premium refund. For a given premium, it generally pays a higher monthly amount than comparable period certain or refund options, as it did in this lesson's stipulated quotes.
• Period certain: pays for the stated period and then stops, even if the annuitant is alive. The beneficiary receives any payments left in the period.
• Life with period certain: pays for the longer of life or the period. The beneficiary receives the remaining count, which does not restart.
• Refund feature: pays for life. If the annuitant dies before payments equal the premium, the difference goes to the beneficiary.
• Joint and survivor: pays while either annuitant lives, starting now. The survivor receives the stated percentage, which is not necessarily 100%. In the plain life-contingent version discussed here, with no remaining period-certain, refund or other continuation guarantee, payments stop at the last death.
• The trade-off: more protection after death means less income per payment. No option is best for everyone.
• Annuity income versus life insurance: plain life-contingent joint and survivor income, with no remaining period-certain, refund or other continuation guarantee, stops at the last death, while second-to-die life insurance pays at the last death.

To practice, pick any option and a stipulated death point. Then state what ends the payments, what continues and the amount or count owed.

Review: Separate a lifetime promise from a fixed period

• Option 1: Life only
• Option 2: Period certain
• Option 3: Life with period certain