7.1 Annuity Payout Options and Annuitization

Annuity Payout Options and Annuitization

An annuity has two halves. During the accumulation (pay-in) phase the owner deposits premium and the contract earns interest or sub-account returns. During the annuitization (pay-out / liquidation) phase the accumulated value is converted into a stream of income. The act of converting the lump sum into periodic payments is annuitization, and once it begins it is generally irrevocable. The exam wants you to know exactly what each payout option promises, who bears the longevity risk, and how the number of lives and any guarantees change the size of each check.

Who is who

Three parties appear on every annuity, and the exam tests the difference because payout depends on the annuitant, not the owner.

• Owner - buys the contract, has all ownership rights, names the annuitant and beneficiary, and may surrender or change the contract during accumulation.
• Annuitant - the measuring life. Payout amounts are calculated on this person's age and life expectancy. The annuitant cannot be changed once payout begins.
• Beneficiary - receives any guaranteed amount remaining if the annuitant dies. A pure life annuity leaves nothing for a beneficiary.

Most contracts are owner-driven, but you should also recognize the annuitant is the trigger for life-contingent payouts.

Pure life (straight life / life-only)

The pure life (also called straight life or life income) option pays the largest periodic check of any option because the insurer's obligation ends at the annuitant's death. There is no refund and no beneficiary payment. If the annuitant dies after only two payments, the insurer keeps the remaining balance. This option transfers longevity risk entirely to the insurer: a long-lived annuitant can collect far more than the account value. Tested trap: pure life always pays the highest income but carries the highest risk of forfeiture.

Life with period certain and life with refund

These options add a guarantee at the cost of a smaller payment.

• Life with period certain - pays for life, but guarantees a minimum number of years (e.g., life with 10-year certain). If the annuitant dies in year 4, the beneficiary collects the remaining 6 years; if the annuitant lives 30 years, payments continue for life.
• Installment refund - pays for life and, if the annuitant dies before recovering the principal, continues installment payments to the beneficiary until the original premium is recovered.
• Cash refund - same idea, but pays the unrecovered balance to the beneficiary in a single lump sum.

More guarantee = smaller check. Pure life > life with refund > life with period certain in size only when periods/refunds differ; broadly, any guarantee lowers the payment versus pure life.

Joint options for two lives

Two-life options measure two annuitants.

• Joint life - pays until the first death, then stops. Rare; produces a larger check than joint-and-survivor because the obligation ends sooner.
• Joint and survivor - pays until the last (second) death. Often written joint and 2/3 or joint and 1/2 survivor, meaning the payment drops to that fraction after the first death. Because the insurer expects to pay over two lifetimes, the periodic amount is the smallest of the common options.

Mnemonic: joint life stops at the first death; joint-and-survivor continues for the survivor.

Period certain and fixed amount (no life contingency)

Not every option depends on living.

• Fixed period (period certain only) - the insurer pays for a set number of years (e.g., 20). If the annuitant dies during the period, the beneficiary receives the rest. There is no lifetime guarantee.
• Fixed amount - the owner chooses the dollar amount of each payment, and the insurer pays that amount until the fund plus interest is exhausted. The time runs out; the amount is fixed.

Contrast these with life options: fixed-period and fixed-amount can leave the annuitant outliving the money.

Worked numeric: comparing payouts

Assume a $200,000 account, a 65-year-old annuitant, and these monthly factors per $1,000 (illustrative):

Math: $200,000 / $1,000 = 200 units. 200 x $6.20 = $1,240 for pure life; 200 x $5.10 = $1,020 for joint and survivor. The pattern the exam wants: the fewer the guarantees and lives, the larger the check.

Annuitization vs. systematic withdrawal

Annuitization is not the only way to take money out. The owner can instead use a systematic withdrawal, taking periodic amounts while keeping ownership and any remaining account value. The trade-off the exam tests:

• Annuitization - irrevocable, but provides a guaranteed payment the owner cannot outlive (for life options) and the highest income because mortality credits are pooled.
• Systematic withdrawal - flexible and revocable, the balance passes to a beneficiary, but the owner bears the risk of depleting the fund and outliving it.

Only true annuitization with a life option eliminates longevity risk; a withdrawal plan does not.

Settlement-option parallels and the annuity unit

The payout options here mirror the life-insurance settlement options (fixed period, fixed amount, life income, interest only) - the exam may test them under either product, and the mechanics are identical. One added concept for variable annuities: at annuitization the account value buys a fixed number of annuity units, and each payment equals the number of units times the changing unit value. So the variable annuitant's check rises and falls with sub-account performance, while a fixed annuity guarantees a level dollar payment for the same option.