What Is a Whole Life Annuity?

A financial product sold by insurance companies that pays monthly, quarterly, semi-annual or annual payments to a person for as long as he or she lives, beginning at a stated age. Annuities are usually purchased by investors who want to secure an income stream during retirement.

Key Takeaways

  • A whole life annuity is also called life annuity.
  • Annuities can either be paid out at a fixed rate or a variable rate, which changes as the underlying investments change price. Most variable annuities allow you to invest in a variety of funds in order to diversify your portfolio.
  • Insurance agents make a commission of annuities sold.

How a Whole Life Annuity Works

Annuities can be structured to make payments for a fixed amount of time, commonly 20 years, or make payments for as long as the annuitant and his or her spouse is alive. Actuaries work with insurance companies to apply mathematical and statistical models to assess risk when determining policies and rates.

The accumulation period occurs as payments are being made by the buyer of the contract to the insurance company; the annuitization phase occurs when the insurance company makes payments to the annuitant.

Annuities can be structured generally as either fixed or variable. Fixed annuities provide regular periodic payments to the annuitant. Variable annuities allow the owner to receive greater future cash flows if investments within the annuity fund do well and smaller payments if its investments do poorly. This provides for a less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund's investments.

Agents or brokers selling annuities need to hold a state-issued life insurance license, and also a securities license in the case of variable annuities. These agents or brokers typically earn a commission based on the notional value of the annuity contract.

Real World Example of a Whole Life Annuity

Investment giant Fidelity offers this example of how an annuity works: A $100,000 lump-sum investment over 20 years, assuming a 6% rate of return for all years for a taxable account, would be worth $222,508 at the end of the term. A tax-deferred variable annuity pre-tax (0.25% annual annuity charge) would be worth $305,053 at the end, and a tax-deferred variable annuity post-tax, assuming lump-sum withdrawal (0.25% annual annuity charge), would be worth $239,436. 

At the end of the term, the value in the account would be turned into a stream of payments in what's called the annuitization phase. There are no IRS contribution limits and any earnings not taxed until withdrawn. Most variable annuities let you invest in a variety of assets, mainly stock mutual funds. Withdrawals of taxable amounts from an annuity are subject to ordinary income tax and, if taken before age 59½, may be subject to a 10% IRS penalty.