Whole Life Annuity

Whole Life Annuity

A whole life annuity (also called a life annuity) is an insurance contract that converts a lump sum into a guaranteed stream of payments for as long as the annuitant lives. People commonly buy them to secure predictable retirement income.

How it works

• Purchase: You pay a lump sum or series of premiums to an insurance company during the accumulation period.
• Annuitization: At a contractually agreed start date, the insurer begins paying you a regular income (monthly, quarterly, semiannually, or annually) for life.
• Pricing: Actuaries set payment amounts using life-expectancy estimates and interest-rate assumptions. Payment size depends on the purchase amount, your age, payout option, and any fees or riders.

Note: A lifetime annuity differs from whole life insurance. A life annuity focuses on guaranteed income; whole life insurance pays a death benefit.

Types of lifetime annuities

• Fixed annuity: Pays a predetermined, stable amount regardless of market performance. Good for predictable income.
• Variable annuity: Payments vary based on the performance of underlying investments (often mutual-fund-like subaccounts). Potential for higher payments, but more volatility.
• Joint-and-survivor options: Continue payments while either you or your spouse is alive (payments may be reduced to account for the longer expected payout).

Taxes, fees, and regulation

• Taxation: Earnings in an annuity grow tax-deferred. Withdrawals of taxable earnings are taxed as ordinary income. Withdrawals before age 59½ may incur a 10% IRS penalty.
• Contribution limits: There are no IRS contribution limits specific to annuities (unlike retirement accounts).
• Fees: Annuities can include mortality and expense charges, administrative fees, and investment management fees (especially for variable annuities). Agents typically earn commissions based on the contract value.
• Licensing: Sellers of annuities need a state life insurance license; variable annuities also require securities licensing.

Considerations before buying

• Longevity risk: Lifetime payments protect against outliving your savings.
• Inflation risk: Fixed lifetime payments can lose purchasing power over time unless the contract includes cost-of-living adjustments or inflation riders (which reduce initial payout).
• Liquidity: Annuities often impose surrender periods and limited access to principal.
• Fees and complexity: Variable annuities and many riders add complexity and cost—compare product fees and surrender terms.
• Insurer strength: Payments depend on the insurer’s ability to pay; check financial strength ratings.
• Beneficiaries: Pure lifetime payouts typically end at death unless you choose options (period certain, cash refund, or joint survivorship) that alter payments or pass value to heirs.

Simple hypothetical example

Assume a $100,000 lump-sum investment and a uniform 6% return over 20 years:
– Taxable account (no tax deferral): ~$222,508 at term end.
– Tax-deferred variable annuity (pre-tax, 0.25% annual annuity charge): ~$305,053 at term end.
– Tax-deferred variable annuity (post-tax, assuming lump-sum withdrawal and a 0.25% charge): ~$239,436 at term end.

These are illustrative comparisons showing how tax deferral and fees can materially affect outcomes; actual results vary by contract, fees, and investment performance.

Key takeaways

• A whole life (life) annuity converts capital into guaranteed lifetime income.
• Choose between fixed (stable payments) and variable (investment-based payments) structures depending on risk tolerance and income needs.
• Consider taxes, fees, liquidity, inflation protection, and the insurer’s creditworthiness before buying.
• Riders and payout options (joint, period certain, refund) alter payments and beneficiary treatment—read contract details carefully.

Questions to ask an insurer or advisor: What fees and riders apply? How does the payout change with different options? What are surrender terms and liquidity limits? What are the insurer’s financial ratings?