An annuity is a contract with an insurance company. You purchase the annuity by depositing funds with the insurance company; in exchange, you can be paid a guaranteed income for a specific period of time. Annuities can be immediate, which means you receive income right away, or deferred, which means you let the funds grow and take your guaranteed income in the future.
When you receive income from an annuity, you must choose the term of the payments. This is also true when you have a pension plan that pays benefits in the form of an annuity. The most common payment methods include life-only, joint-life payment, term certain, and life with term certain.
- You must select the term and timing of the payments you want at the time you purchase an annuity.
- Life-only payments will continue as long as you’re alive, but they stop immediately upon your death.
- Joint-life payments might be appropriate if you’re married because they’ll continue throughout the lifetimes of both spouses.
- Term-certain payments are paid for a specified number of years, and can continue after your death.
1. Life-Only Annuity Payments
Life-only payments continue as long as you live. But they stop immediately upon your death. Even if you live for 40 or 50 years after you start receiving payments, the guaranteed payments will continue. This is true as long as the insurance company stays in business.
Every state has a system in place to protect policyholders if an insurance company goes out of business. It depends on the laws in your state. There may be a limit on how much you can be paid, though.
If you choose a life-only option, start receiving payments, and pass away one year later, the insurance does not return the rest of your principal to your heirs. You may have the option to purchase a principal refund option; this will cost more. It makes life-only annuity payments a better choice for singles with no children. But it may not be a great choice for married couples.
A life-only annuity term will result in a higher monthly income payment than a joint-life term.
2. Joint-Life Payments
These are most often used by couples. Joint-life annuity payments are structured similarly to life-only. The difference is that payments will continue as long as either spouse lives.
Although you will get a lower monthly income than with a life-only option, the joint-life annuity option ensures that income will continue to a surviving spouse.
Many pension plans offer a variation of joint-life payments. This allows the surviving spouse to receive 50% or 75% of the benefit instead of 100%. This option could be used if the spouse would need a portion of your pension income upon your death, but not all of it.
If you choose 100% of the benefit to continue to a surviving spouse, you will receive a slightly lower monthly income than if you choose 50% to continue to a surviving spouse.
If you're married, you need to decide about how your pension benefits will pay out. Be sure to study all of the pension survivor benefit options offered by your company. It will help you become familiar with the features as well as the pros and cons.
3. Term Certain Annuity Payments
Also known as period certain, these annuity payouts are for a set term. A 10-year term certain annuity payout means that payments are guaranteed to be made for at least 10 years. If you were to pass away during the first year, payments would continue to your named beneficiary until 10 years after the first payment.
After the initial 10 years, payments stop. Term certain annuities can be a good way to provide income in situations where you have a secondary source of income that will start at a later date.
For instance, let's say you retire at 60. But your pension benefit will not start until age 65. You could consider buying a five-year term certain annuity to provide income for the five years between ages 60 and 65.
Term certain payouts can also be a good choice for a younger spouse where it is most likely they will live longer. The term certain provides some security for the older spouse just in case the younger spouse passes first.
4. Life With Term Certain Payments
This option pays income for your lifetime or for a set period, whichever is last. For example, you might opt for life with a 10-year term. If you live for 20 years after you start payments, you receive income for that entire time.
If you were to die two years after receiving payments, your beneficiary would receive payments for eight years to complete your 10-year term.
The Bottom Line
Any of these payout options can work. The best one for you depends on whether you have dependents, your age and health, and the other financial resources you have.
While the life-only option has the highest payout, it might be worthwhile to have a lower payment and the security of knowing the payments may continue after your death.