Annuities

Fun Facts

Annuities have existed for over 1800 years. In Rome, contracts called Annua promised income streams for a given number of years or for life in return for a up front sum of money. Wealthy Romans often willed their friends or family an income for life.  Now I call that a good friend. 

In the 1600?s special annuity pools called Tontines operated in France. For a specified payment purchasers received lifetime payments. 

William Shakespeare near the end of his life is said to have invested in an annuity like investment. 

As early as 1540 the Dutch government sold annuities to finance the war and public works, much like modern day state and government bonds. 

The first record of annuities in the United States is around 1759. After the stock market crash of 1929, many people turned to annuities for a safe place to store retirement money.

As of 2007, Americans have saved more than $1 trillion in annuities. Many finance professors and economist hope that Americans nearing retirement will rediscover the original purpose of annuities, guaranteed income for life.

What is an Annuity?

An annuity is a contract between an individual (referred to as the “annuitant") and an insurance company. The annuitant pays the insurance company either a single payment or a series of payments, and in return, the insurance company agrees to pay the annuitant, or a designated beneficiary, an income for a specified time period. The time period can start immediately or can begin at a later date.

Types of annuity products

There are two basic types of annuities that can be purchased, fixed and variable. Fixed annuities earn a guaranteed rate of interest for a specific time period, such as one, three or five years. Once the guaranteed period is over, a new interest rate is set for the next period. Variable annuities offer a range of investment options (called “subaccounts”), which can include stocks, bonds, and money market instruments. The return on a variable annuity is not guaranteed and can rise or fall depending on the value of the underlying investment option.

Annuities can also be deferred or immediate. Deferred annuities accumulate money over time and generally begin payouts after retirement. Distribution of payments for immediate annuities typically begins within a month of purchase. The income payments received from fixed immediate annuities are based on the purchase amount of the annuity, the annuitant’s age, and the interest rate environment at the time of purchase.

 

Medicaid-friendly annuities

These annuities are typically fixed, single premium immediate annuity (SPIA) instruments. A purchaser of an immediate annuity has several options for receiving income.

The main types used in Medicaid-planning are:

Life only annuities: In this type of annuity, the insurer makes periodic payments to the annuity beneficiary for the life of the annuitant only. This produces the largest periodic payment for the beneficiary, but no provision is made for heirs because the contract terminates on the death of the annuitant. A substantial loss can occur if the annuitant dies early.

Life annuities with refund provisions: There are two types of refund provisions that can allow the annuity to provide for heirs if the annuitant dies within a pre-set number of years. The annuity can be set to pay for “life with ‘X’ years certain,” which would pay for either the life of the annuitant or a set number of years, whichever is greater. Or, the annuity can be set to pay for “life with installment refund,” which guarantees that the total annuity payments will at least be equal to the premium paid to the insurer. In a Medicaid-friendly annuity, the “X years certain” guaranteed cannot be longer than the actuarial life expectancy of the annuitant.

Period certain annuities: The payment period for these annuities is not dependent upon the life of the annuitant. Payment is guaranteed and will be made to either the original beneficiary or, in the event of the original beneficiary’s death, to the remainder beneficiary. Again, the length of the period certain cannot be greater than the actuarial life expectancy of the annuitant.

Interest only annuities: These annuities generally make only interest payments during the life of the annuity contract, making a lump-sum payment at the end of the annuity contract period. Several States have moved to prohibit the purchase of this type of annuity by Medicaid applicants. When a guarantee period is chosen the dollar amount of the periodic payment will be less. One industry representative interviewed noted that guarantee periods are economically irrational, but people still chose them if they are hoping to maximize their bequest to heirs.

As we noted above, Medicaid annuities are typically SPIAs. This type of annuity is not likely to vary by State. However, there are rules that vary by State related to the maximum age of an annuitant. Insurance companies are prohibited from selling annuities to very aged individuals because the annuitant or  their beneficiaries would be unlikely to get a return on his/her purchase. The maximum issue age is typically in the late 80s, but can go as high as 94 years of age.

 

Source: 2004 Annuity Fact Book, National Association for Variable Annuities (NAVA)