At their most basic function, annuities are intended to provide a stream of income in exchange for a lump sum purchase price. The insurance companies that sell annuities offer a range of ways to structure the payout, including an income that lasts for the life of an individual or even two people. A non-life contingent annuity is another income option that may be appropriate to meet specific goals.
If you buy an annuity that will earn interest and grow in value, the contract is classified as a deferred annuity. An annuity that is purchased to start paying a monthly income is an immediate annuity. A deferred annuity is annuitized to change to the immediate annuity income stream payout. The annuitant is the person who receives the annuity payments. Non-life contingent annuity applies to an immediate annuity payment option.
Annuity Payout Options
A life annuity is a monthly income payment that is guaranteed to last until the annuitant dies, which may be months or many years in the future. The amount of the annuity payments depends -- is contingent -- on the annuitant's life expectancy and the interest rate the insurance company earns on its investments. A fixed-period annuity results in payments for a specific period, such as 10 or 20 years. The payments continue to the end of the term, even if the annuitant dies, so the fixed period payment option is non-life contingent.
Using Time-Specified Annuities
A fixed-period annuity provides a large payment compared to alternatives, because the monthly amount is based on both the principal being paid out and interest earnings. The payments are guaranteed by the insurance company, eliminating the chance of a surprise reduction. Non-life contingent annuities can be used to fund a limited term income requirement. An example might be to purchase a guaranteed monthly check until the annuitant is eligible for Social Security or the start of pension payments. If the person receiving the fixed-period annuity checks dies, the remaining payments will go to the beneficiaries.
Tax Advantaged Payments
Since the payments from a fixed-period annuity consist of both interest and a return of the premium paid for the annuity, the taxable amount will be less than the amount of the annuity payments. The insurance company selling the annuity will provide an exclusion ratio, which shows what portion of the annuity payments are not taxable income. With a non-life contingent, fixed-period annuity, the principal repayment and taxable income are spread evenly over the term of the annuity, softening the tax consequences.
- The Standard: Annuity Answer Book
- Texas.gov: Understanding Annuities
- Edward Jones: Annuity Taxation
- IRS. "IRA FAQs - Contributions." Accessed Oct. 30, 2020.
- Internal Revenue Service. "When Can a Retirement Plan Distribute Benefits?" Accessed Oct. 30, 2020.
- Annuity.org. "Deferred Annuities." Accessed Oct. 30, 2020.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.