Annuity Funds: Distribution Types
The word annuity refers to the payment of money over time, but it has come to be associated with the insurance contract of which the distribution of annuity funds is the concluding feature. Since the contract takes its name from those money distributions, it is appropriate to examine their different forms.
The classic form of annuity funds distribution is the regular, level payment annuity, distributed for the life of the holder. Payments may be made monthly, quarterly, semiannually or annually. A death benefit, minimally consisting of a lump sum equal to all payments made into the annuity minus any partial withdrawals, is a normal feature. Alternatively, the beneficiary may continue to receive the annuity payments.
Departures from the classic level-periodic model take two forms – variances in either the size of the payments or their duration.
Here, the size of the payments increases with each regular payment.
This annuity funds distribution plan includes a provision for an increase in the size of payments should the life expectancy of the holder decrease during the life of the contract. This provision is common when the holder is a smoker.
This provision carries over the accumulation principle of a variable annuity into distribution. It makes each regular payment amount contingent on the investment performance of the holder’s mutual funds and/or bond funds - the better the performance, the higher the payout.
This is a pure form of the level periodic distribution, particularly associated with immediate annuities, in which the holder receives guaranteed income for life. Upon the holder’s death, however, remaining undistributed income reverts to the insurance company.
This provision limits the distribution of annuity funds to a specified time period. It is useful for meeting a temporary funding need, such as paying regular, fixed expenses for a limited time. Premia for specialized forms of life insurance are sometimes paid using period-certain annuities. It is also combined with lifetime immediate annuities to provide for continuing annuity payments to survivors in the event of the holder’s death.
In a provision tailored for couples, payments continue for as long as either of two parties to the annuity contract survives.
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Payments continue for as long as both parties to the annuity contract survive, but cease with the demise of either party.
This delays the onset of distribution substantially from the time payments are received by the insurance company. The delay enables the holder to greatly reduce the cost of insuring against exhaustion of assets. The insurance company has more time to invest proceeds and less actuarial life to provide for, so it takes less money to fulfill the purpose of the annuity.
Death benefits are a standard feature of annuities, the chief exception being immediate lifetime annuities. Unlike the provisions described above, death benefits distribute annuity funds to the beneficiary or beneficiaries rather than the holder or holders of the annuity. Death benefits take on special significance in deferred variable annuities, in which the accumulation balance varies with market conditions and investment performance and the balance might fall below the sum of contributions made by the holder. At a minimum, the death benefit provides a lump sum equal to the sum of payments made to the insurance company, less any partial withdrawals. An improvement on this minimum guarantee would be to specify a minimum guaranteed rate of return on the accumulated payments. Another provision would guarantee the maximum value reached by the account on any specified anniversary date. Lastly, an even more favorable option would be the ability to select the most favorable of the foregoing choices.
One of the newest features of variable annuities, these optional riders set minimum guarantees for income, or accumulation in the account at a specified point in the future, the capability of withdrawing income without having to switch to annuitization, and even provisions that offer larger lifetime income guarantees by melding the concepts of withdrawing investment income and annuitization.
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