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An annuity is a contract that pays out income for a set number of years, or for as long as a named person lives. Its defining purpose is to protect that person against outliving their own resources. Although annuities are sold by life insurance companies and administered by licensed life agents, they are fundamentally different from life insurance: rather than paying a benefit when someone dies, an annuity accumulates funds during a person's life and then converts, or liquidates, that accumulated sum into income.
Annuities generally work in the opposite direction of a life insurance policy: instead of paying a face amount at death, payments from most annuities simply stop when the annuitant dies. Annuities do rely on mortality tables, just as life insurance does, but annuity mortality tables assume a longer life expectancy than the tables used to price life insurance — an insurer providing lifetime income has every incentive to be conservative about how long it may have to keep paying. Mortality tables show, for a defined group (such as males, females, smokers, or nonsmokers) starting at a given age, how many members of that group are statistically expected to still be alive at each later age.
Owner — the person or entity that purchases the annuity contract. The owner is not necessarily the one who receives its benefits, but holds every right associated with the contract, including the right to name or change the beneficiary and to surrender the annuity. An owner may be an individual, or a corporation, trust, or other legal entity.
Annuitant — the person whose life expectancy determines the annuity's payments, and for whom the contract is written. The annuitant and the owner are frequently the same person, though they don't have to be. Because annuity payments hinge on a person's life expectancy, the annuitant must always be a natural person — a corporation or trust may own an annuity, but it can never serve as the annuitant.
Beneficiary — the party entitled to receive the annuity's assets — either the amount paid in or the current cash value, whichever is greater — if the annuitant dies during the accumulation period, or to receive whatever balance remains if the annuitant dies during the payout period.
Because annuities are priced on the annuitant's life expectancy, the annuitant must be a natural person, no matter who owns the contract.
The accumulation period, also called the pay-in period, is the span of time during which the owner makes payments into the annuity, and during which those payments earn interest on a tax-deferred basis.
The annuity period — also known as the annuitization period, liquidation period, or pay-out period — is the time during which the sum built up during the accumulation period is converted into a stream of income paid to the annuitant. The annuity period may last for the annuitant's remaining lifetime, or for some other specified span, longer or shorter. The annuitization date is the point at which those payouts actually begin.
Funds are paid INTO the annuity during accumulation, and paid OUT to the annuitant during the annuity (annuitization) period.
The size of each annuity income payment depends on several factors: the amount of premium paid or cash value accumulated, how frequently payments are made, the interest rate credited, and the annuitant's age and gender. An annuitant with a longer remaining life expectancy will receive smaller individual payments than one with a shorter life expectancy, since the insurer expects to make payments for a longer stretch of time.
All else being equal, a 70-year-old man will receive a larger monthly annuity payment than a 50-year-old man, because the 70-year-old has a shorter remaining life expectancy. That same 70-year-old man will also receive a larger payment than a 70-year-old woman of the same age, since women statistically live longer than men.
Shorter life expectancy means a higher individual benefit payment; longer life expectancy means a lower one.
If the annuitant dies during the accumulation period, the insurer is obligated to pay the beneficiary either the accumulated cash value or the total premiums paid, whichever amount is greater. If no beneficiary has been named, that death benefit is instead paid to the annuitant's estate.