Review of Annuity Basics
Before you can understand the unique features of variable annuities, it will be helpful to review what annuities are. An annuity is a contract between an insurance company and an annuitant, i.e., the person on whose life expectancy the annuity is based.
The annuitant pays premiums to the insurance company either as a single lump sum premium or as part of a flexible premium arrangement (periodic payments of premiums). This part of the contract is called the accumulation period. After the accumulation period is over, the account is annuitized—the insurance company begins paying the annuitant a regular income, usually on a monthly basis, for some period, called the payout period.
There are a variety of payout options available for annuities.
The traditional life annuity pays regular income as long as the annuitant lives: if he or she lives long enough, the annuitant will get more out during the payout period than he or she put in during the accumulation period; but in any event, the payments stop when the annuitant dies.
Joint and survivor annuities pay for the life of the annuitant and a beneficiary, usually a spouse. Period certain annuities pay regularly for a set term, whether or not the annuitant dies; and refund annuities refund any value left in the annuity to beneficiaries upon the annuitant's death. The ability of an annuity to provide a source of income that you cannot outlive is a key distinguishing feature, compared to many other financial instruments.
With traditional fixed annuities, annuitants pay into a general fund, which the insurance company invests. Whatever payout option the annuitant selects, the interest gains and payment amounts are guaranteed.
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