Annuities
Questions:
- What are annuities?
- What is an immediate annuity?
- What is a deferred annuity?
- What is a joint life annuity?
- What is a survivorship annuity?
- What is a life annuity?
- What is a guaranteed annuity?
- What is an annuity period certain?
- What is a superannuation scheme?
- What is a defined contribution scheme?
- What is a defined benefits scheme?
1. What are annuities?
Annuities are contracts whereby the insurance company makes a series of payments at regular intervals from a fixed date until the death of the annuitant. In return for this benefit, the annuitant will have to pay a certain sum of money, known as the purchase price. The purchase price can be made in one lump sum or in a series of payments. If this mode of payment is chosen, the annuity payments can only commence after all the payments (of the purchase price) have been made.
Each annuity payment represents the repayment of a portion of the purchase price plus the interest earned. There are many kinds of annuities as will be described in the following answers.
2. What is an immediate annuity?
An immediate annuity is one in which the annuitant pays a lump sum as the purchase price and in return, he/she receives annuity payments. The annuity is referred to as immediate because the purchase price is payable immediately and the first annuity payment also starts immediately after one payment interval.
Depending on period of payments, an immediate annuity may also be classified as life, guaranteed or period certain annuity.
3. What is a deferred annuity? A deferred annuity is one in which the annuity payments will commence only at the end of a specified period of years.
The specified period of years is known as the deferred period. The purchase price may be paid either by premiums during the deferred period or by a single lump sum payment at the start.
Premiums are usually refundable with or without interest if the annuitant dies during the deferred period. In addition, there will be surrender values available during the deferred period.
Like immediate annuity, depending on period of payments, a deferred annuity may also be classified as life, guaranteed or period certain annuity.
4. What is a joint life annuity?
A joint life annuity is one where there are two or more annuitants. The annuity payments will cease on the occurrence of the first death among the annuitants.
5. What is a survivorship annuity? A survivorship annuity is one which is issued on two or more lives and provides for annuity payments to be made until both or all of the annuitants have died. Married couples often purchase survivorship annuities so that when one spouse dies, the remaining spouse will continue to receive the annuity benefits for the rest of his/her life.
The majority of survivorship annuities specify that the size of each annuity payment will remain the same throughout the annuity payment period, although some such annuities specify that the annuity payments will be reduced after the death of the first annuitant.
6. What is a life annuity?
A life annuity is one in which the annuity payments are payable until the annuitant dies. Once the annuitant dies, the contract is fulfilled and no more payments are made. If an annuitant died shortly after the life annuity payments began, the total amount the annuitant would have received in benefits could have been lower than the amount paid for the annuity.
7. What is a guaranteed annuity? A guaranteed annuity is one in which the annuity payments are payable for a guaranteed number of years and thereafter, continue until the annuitant is dead. This fixed number of years is called the guarantee period. If the annuitant dies during this period, the annuity payments (or one discounted lump sum) will continue to be paid (to the beneficiaries) until the end of the guarantee period.
8. What is an annuity period certain? An annuity period certain (more commonly referred to as annuity certain) is one in which a specified number of annuity payments (of a set amount) is provided for and guaranteed. The specified period over which the annuity payments are made is called the period certain. At the end of the period certain, the annuity payments cease, even if the annuitant is still alive. If the annuitant dies before the end of the period certain, the remainder of the annuity payments are paid to a beneficiary named in the contract by the annuitant.
The annuity payments are paid at regular intervals such as every year, half year, quarter or month. An annuity period certain may be immediate or deferred. Payments for an immediate annuity will commence one payment interval after the annuity has been issued. Payments for a deferred annuity will commence much later but as specified in the annuity contract. All else being equal, a deferred annuity will offer bigger or more payments than an immediate annuity.
Surrender values are also (usually) allowable at any time prior to the final annuity payment. Annuity period certain is useful when a person needs an income for a specified period of time.
9. What is a superannuation scheme? A superannuation scheme is a contribution scheme whereby a series of payments is made to the company administering the scheme. At the time of maturity of the scheme (usually at the age of retirement), the monies accumulated together with the interest earned will be paid to the member of the superannuation scheme. The accumulated sum may be payable in one lump sum or in a series of payments, depending on the choice of the members.
10. What is a defined contribution scheme? A defined contribution scheme is a superannuation scheme in which the contribution is determined at the outset of the scheme. The contribution is usually expressed as a fixed percentage of the member's salary. In this case, the ultimate benefit to be received at retirement cannot be determined in advance as it will depend on the scheme's investment returns. If the scheme has a superior performance during the term of the membership, the member will receive a large sum of money at retirement, and vice versa.
A well known example is the Malaysian Employee Provident Fund (EPF).
11. What is a defined benefit scheme? A defined benefit scheme is a superannuation scheme in which the benefit payable is determined at the outset of the scheme. The benefit is usually expressed as a multiple of the average annual salary (if payable in one lump sum) or a percentage of the last drawn salary (if payable monthly until death). The average annual salary is usually used instead of the annual salary of the final employment year because an employer can intentionally increase a retiring employee's annual salary in his/her last year of employment just so that he/she can be entitled to a larger benefit from the scheme. For example, we can have an ultimate benefit of 3 times the average annual salary of the last 5 years of employment. In this case, the amount of contribution will vary from year to year according to whether the ultimate benefit is achievable. Every year, an actuary will have to determine the amount of contribution to the fund to achieve the defined benefits.
An example is a pension scheme.