What Is a Life Annuity?

The term life annuity refers to a financial product that features a predetermined periodic payout amount until the death of the annuitant. An annuitant typically pays into the annuity on a periodic basis when he or she is still working. Annuitants may also buy the annuity product in one large, lump-sum purchase—usually at retirement. Life annuities are commonly used to provide guaranteed and/or supplemental retirement income that cannot be outlived.

Key Takeaways

  • A life annuity is a financial product that features a predetermined periodic payout amount until the death of the annuitant.
  • Annuitants pay premiums or make a lump-sum payment to secure a life annuity.
  • Life annuities are commonly used to provide or supplement retirement income.
  • While most life annuities make payments monthly, others pay distributions quarterly, semi-annually, or annually.

How a Life Annuity Works

Life annuities are insurance or investment products that provide the beneficiary with fixed payments are regular intervals—either monthly, quarterly, annually, or semi-annually. Life annuities, also known as lifetime annuities, are generally sold by insurance companies. They essentially act as longevity insurance, as the risk of outliving one's savings is passed on to the annuity issuer or provider.

Life annuities come in two different phases. The first is the accumulation or deferral stage. This is the period when the buyer funds their annuity with premiums or with a lump-sum payment. The second stage is the distribution or the annuitization phase. During this period, the issuer makes regular payments to the annuitant. Once funded and enacted, the annuity makes periodic payouts to the annuitant, thus providing a reliable source of income. The issuer normally stops making periodic payments if the annuitant dies or if another triggering event occurs to close the annuity. But these payments may continue to the annuitant's estate or beneficiary if the annuitant purchases a rider or other option on the annuity.

Since most life annuity payouts stop after the death of an annuitant, you may need to purchase a rider if you want your beneficiary to continue receiving payments.

The majority of annuities generally pay a benefit every month, but there are some that make quarterly, annual, or semi-annual payments. Payment intervals depend on the specific needs of the annuitant or their tax circumstances. Many retirees fund a life annuity to match their recurring housing costs—mortgage or rent—as well as any other costs such as assisted living, health care, insurance premiums, and/or medical expenses. While a life annuity pays a guaranteed income, it is not indexed to inflation, so purchasing power may erode over time. A life annuity, once enacted, is not revocable.

Special Considerations

It's important for people to consult a reputable professional before purchasing any annuity product. That's because annuity products tend to be fairly complex in nature with major implications for the annuitant's standard of living, Due to the tax-preferred nature of annuities, very wealthy investors or above-average income earners often use these life insurance products to transfer large sums of money or to mitigate the effects of taxes on their annual income.

While life annuities are often used to provide or supplement retirement income, they are also used as a payment method in structured settlements and for lottery winners. For instance, if someone wins a lawsuit, they may be provided with a series of fixed, regular payments to the beneficiary. Lottery winners may opt to take a lottery annuity rather than a fixed, lump-sum when they win large jackpots. These payouts provide regular payments annually over a certain number of years. For example, a Mega Millions jackpot winner can choose to take 30 payments—one paid out immediately. The remaining payments are distributed annually for the next 29 years.

Types of Annuities

There are several kinds of life annuities. Each of these serves its own purpose. For example:

  • An immediate annuity only has a distribution phase, as is also the case with a payout annuity, an income annuity, or a single-premium immediate annuity.
  • A guaranteed annuity—also called a year's certain annuity or a period certain annuity—pays out for a certain period and continues to make payments to a beneficiary or estate after the annuitant's death.
  • A fixed annuity pays out a fixed percentage.
  • A variable annuity pays out based on the performance of a basket of investments or an index.
  • A joint annuity makes payouts until both spouses die, sometimes at a reduced amount after the death of the first spouse.