What is a life annuity contract?

The key feature of a life annuity contract is that it is payable for a person’s lifetime.  The basic requirements of a life annuity contract are set out in the description and purpose of an annuity that is payable for the lifetime of the owner. Below is an explanation of the parties to an annuity contract as well as the various options available to you to allow you to tailor your annuity contract.

Parties to an annuity contract

A life annuity contract is created when you pay a lump sum to a life annuity contract issuer and agree on the terms of payments to be returned to you at regular intervals over your lifetime. The issuer of life annuities is usually a Life Insurance Company. The purchaser of an annuity is the person who wishes to receive the regular payment. The person who receives the regular payments of an annuity is referred to as the annuitant. The annuitant might be two people in which case they are referred to as joint annuitants. There are occasions where the purchaser of an annuity and the annuitant are different persons.

There are two different kinds of annuities:

  • Guaranteed annunities
  • Equity linked annuities

Guaranteed annuities explained

Guaranteed annuities are the traditional annuities and the older of the two under which the promised benefits are 100 per cent guaranteed by the issuer. Under a guaranteed life annuity, the level of income promised to the annuitant is based on the long term prevailing market interest rate at the time the annuity is purchased. Under this kind of annuity, the regular annuity is payable for the lifetime of the annuitant or another person.

Equity linked annuities explained

An equity linked annuity offers no guarantee of what you will earn from your annuity because the underlying investments from which the annuity is paid by the insurer is invested in equities or unit trusts and the return on these is uncertain. Equity linked annuities offer no certainty of income or the term over which the regular payments are receivable. The annuitant carries the risk.

Options available for guaranteed annuities

The initial payment for the annuity determines how much will be paid out as an income stream. The age of the person receiving and the annuity and their life expectancy determines the level of income they will receive. An older person will receive a higher income because of a lower life expectancy.

With reference to guaranteed annuities, the individuals can decide which of the following is important to them.

  •  the period over which the annuity is payable
  •  frequency of the income payments, and
  •  whether the payments escalate or reduce.

An annuity can be payable for a person’s lifetime or may be limited to a certain period. If it’s limited to a certain period, the income stream will generally be higher.

When you purchase an annuity, you can choose to have regular payments made annually, bi-annually, quarterly or monthly. Annuities are generally paid in arrears and less frequent income payments will result in slightly better income levels.

At the start, you can choose whether the life annuity is to change in line with changes in the consumer price index. Furthermore, if you have chosen a joint annuitant, you may elect a reduced annuity to be paid to the surviving joint annuitant on your death. By electing a reduced income for the second annuitant, you will benefit from a higher income stream initially.

External information

MoneySmart definition and description of annuity