A life annuity with no refund feature continues annuity payouts only as long as the annuitant (or one of the annuitants) survive, with no final payment or refund at the death of the last annuitant, even if the total paid out of the annuity is less than the amount invested in the contract. This can involve a high amount of risk, as the death of a lone annuitant shortly after contract issuance could result in a forfeiture of virtually the entire original deposit.
Example. Mr. Smith purchases an immediately annuity for $50,000 that provides for payments of $300 per month for life, and dies after only receiving two payments, his total return out of the contract will be only $600. He will forfeit the remaining $49,400 of his original deposit to the insurance company, which will use the proceeds to help offset the payments due to annuity holders that outlive their life expectancies.
Because many investors are reluctant to forfeit a portion of their investment in the event of the premature death of the annuitant—particularly if they have heirs that will ultimately inherit all assets not consumed by the individual during his/her life, insurance companies also offer annuity contracts with minimum payback guarantees, These guarantees take two forms.
Refund annuities promise to pay the difference between the amount invested in the contract (generally the total of the premiums paid) and the annuity payments actually paid out before the death of the annuitant. This refund takes the form either of a lump-sum cash payment or of installment payouts.
Period-certain annuities promise to make payments for a stipulated period, such as 5, 10, or 20 years, or for the annuitant’s life, whichever is longer. However, keep in mind that, due to the time value of money, this guarantee still does not make the annuity holder entirely whole in comparison to having invested the assets in an alternative to begin with (where they would have ostensibly been growing during this time period, not merely preserving the original principal amount).
The payout period also may be short-term—that is, for a specified period generally shorter than the expected life (or lives) of the annuitant(s). Term-certain annuities operate similarly to the amortization of a loan. Payments continue for a specified term only, regardless of when the annuitant dies. A temporary annuity is a variation on the period-certain annuity concept. However, rather than paying a specified amount for the longer of the annuitant’s life or the specified term, a temporary annuity continues payments only for the shorter of the annuitant’s life or the specified term.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM