Life Annuity

Life Annuity

What is a life annuity?

A life annuity is an insurance contract that pays a guaranteed stream of income to the annuitant for as long as they live. It is typically funded during an accumulation phase (periodic contributions or a lump sum) and then converts into an annuitization phase when regular payments begin. Life annuities are commonly used in retirement planning to provide income that cannot be outlived.

How life annuities work

• Accumulation phase: You fund the annuity by making premiums or a single lump-sum payment.
• Annuitization phase: The insurer makes regular payments to the annuitant (monthly, quarterly, semi‑annual, or annual).
• Duration: Payments generally stop at the annuitant’s death unless a rider or payout option extends payments to a beneficiary or estate.
• Irreversibility: Once annuitization begins, contracts are typically irrevocable.
• Purchasing power: Most standard life annuities are not indexed to inflation, so real purchasing power can decline over time.

Common types of life annuities

• Fixed annuity: Pays a predetermined interest rate or fixed dollar amount. Stable and predictable.
• Variable annuity: Payouts depend on the performance of underlying investments (subaccounts). Potential for higher returns, but also greater risk and variability.
• Joint annuity: Covers two people (often spouses); payouts continue until both have died. Payments may be reduced after the first death depending on the option selected.
• Qualified Longevity Annuity Contract (QLAC): A deferred annuity purchased with funds from a qualified retirement plan or IRA. QLACs begin payments later in life and are exempt from required minimum distribution (RMD) rules while held within the contract.

Typical uses

• Retirement income to replace or supplement pensions and Social Security.
• Covering predictable expenses such as housing, insurance, and medical costs.
• Structured settlements and lottery payouts (where recipients may choose annuity payments instead of a lump sum).

Key factors to consider

• Inflation risk: Fixed payouts usually aren’t inflation‑adjusted.
• Beneficiary protection: If you want payments to continue after death, choose a rider or guaranteed-period option; these typically lower the periodic payout or add fees.
• Tax treatment: Annuities offer tax-deferred growth; the tax implications of distributions vary by type and funding source. Consult a tax professional.
• Liquidity and flexibility: Many annuities restrict access to principal once annuitization begins and may charge surrender fees during accumulation.
• Fees and commissions: Variable annuities often carry higher fees for investment management and riders.
• Suitability: Annuities can materially affect long‑term finances and standard of living; discuss with a financial advisor to align product features with goals and needs.

Frequently asked questions

Q: What’s the main difference between a fixed and a variable annuity?
A: A fixed annuity guarantees a set payment or interest rate; a variable annuity’s payments vary with the performance of underlying investments, offering greater upside and greater risk.

Q: How does a joint annuity work?
A: A joint annuity continues to pay until both covered individuals have died. Payouts often drop after the first death if a survivor option isn’t full‑benefit.

Q: What is a QLAC and why consider it?
A: A QLAC is a deferred annuity bought with qualified-plan or IRA funds that delays required minimum distributions for the portion invested in the QLAC. It provides longevity protection by starting payments later in life.

Bottom line

Life annuities provide guaranteed lifetime income and can be a useful tool to manage longevity risk in retirement. They involve tradeoffs—reduced liquidity, often no inflation protection, and long‑term commitment—so evaluate product features (payout options, riders, fees, tax consequences) and consult a trusted financial or tax advisor before purchasing.