7.1 Annuity Payout Options and Annuitization

Annuitization: Turning Accumulation Into Income

Every deferred annuity has two phases. During the accumulation phase, premiums grow tax-deferred. Annuitization is the act of converting the accumulated value into a stream of payments during the payout (annuity) phase. Once a contract is annuitized under a settlement option, the choice is generally irrevocable — the owner cannot reverse it or take the lump sum back. This is the single most-tested fact about payout: annuitization is permanent.

The insurer calculates each payment using the annuitant's age, gender, the account value, and an assumed interest rate. The annuitant (the person whose life the income is measured against) is sometimes called the measuring life. The older the annuitant at annuitization, the larger each payment, because the insurer expects to make fewer total payments.

Life-Contingent (Annuity) Options

Life-contingent options pay for as long as the annuitant lives — they pool mortality risk, so they pay the most per dollar but risk forfeiture at early death.

• Straight Life (Life Only / Pure Life): Pays for the annuitant's lifetime, then stops. Highest monthly income of any option. If the annuitant dies after one payment, the insurer keeps the balance. Maximum income, maximum risk of loss.
• Life with Period Certain: Pays for life, but guarantees a minimum number of years (e.g., 10 or 20). If the annuitant dies before the period ends, a beneficiary receives payments for the remainder of the certain period. Lower income than straight life.
• Life with Refund (Cash or Installment Refund): Guarantees that total payments equal at least the premium paid. If the annuitant dies early, the beneficiary receives the difference as a lump sum (cash refund) or continued installments (installment refund).
• Joint Life: Pays while both annuitants live; stops at the first death.
• Joint and Survivor: Pays while either annuitant lives; continues (often at 50% or 100%) until the second death. Lowest income because two lives are covered.

Non-Life-Contingent Options

These do not depend on anyone living and carry no mortality pooling — payments are guaranteed regardless of death.

• Fixed Period (Period Certain): Pays a level amount for a chosen number of years (e.g., 15 years). The insurer liquidates principal and interest over that span. Any value remaining at the annuitant's death goes to a beneficiary.
• Fixed Amount: Pays a chosen dollar amount each period until principal and interest are exhausted. Here the amount is fixed and the duration varies — the opposite of fixed period.

Exam Traps and Worked Numbers

Trap 1 — Fixed Period vs. Fixed Amount. In fixed period the number of years is set and the payment is solved for; in fixed amount the payment is set and the number of years is solved for. Memorize which variable is locked.

Worked example: A $120,000 annuity is annuitized under a 10-year fixed-period option. Ignoring interest, the base liquidation is $120,000 / 120 months = $1,000/month. With credited interest, the actual payment is higher, but the exam often uses the simple division to test the concept.

Trap 2 — Straight life pays the most. Because nothing is guaranteed to a beneficiary, straight life always produces the largest periodic payment for a given account value and age. Adding any guarantee (period certain, refund, survivor) reduces the payment.

Trap 3 — Joint life vs. joint and survivor. Joint life stops at the first death; joint and survivor continues to the second death. Candidates routinely swap these.

How Settlement Factors Work

Insurers express payout using settlement option tables stated as a monthly income per $1,000 of accumulated value. Suppose a table shows a straight life factor of $6.20 per $1,000 for a 70-year-old male. A $250,000 account produces 250 x $6.20 = $1,550/month. The same age under a 10-year period certain might show $5.85 per $1,000, giving 250 x $5.85 = $1,462.50/month — proof that adding a guarantee lowers income.

Two forces drive the factor: the annuitant's life expectancy (older = fewer expected payments = higher factor) and the assumed interest rate the insurer credits on the unpaid balance. A higher assumed rate raises each payment. Gender historically affects factors because of mortality differences, though some jurisdictions and qualified plans require unisex rates.

Choosing Among Options in Practice

The right option depends on the client's goals. A single retiree with no dependents who wants maximum income and has other assets for heirs may rationally choose straight life. A retiree supporting a spouse usually chooses joint and survivor so income continues after the first death. A client wanting to guarantee a legacy regardless of how long they live may prefer refund or period certain.

Remember the timing rules. A deferred annuity owner may surrender for cash before annuitizing, but once a life-contingent settlement option is elected, the value is committed to the income stream. The annuity date (also called the maturity date) is when payments must begin; many contracts default to straight life if the owner makes no election.