Every lifetime annuity needs three parties: the contract’s owner, its annuitant and its beneficiary. In an annuitant-driven contract, the annuity ends and pays out to the beneficiary when the annuitant dies. In an owner-driven contract, the annuity ends and pays out to the beneficiary when the contract’s owner dies. This is a seemingly straightforward system that can actually lead to several complications, as we’ll discuss below. If you’re struggling to understand the various types or pieces of an annuity that you’re considering, then you may want to enlist the help of a financial advisor.
What Is an Annuity?
An annuity is a financial contract typically issued by a life insurance company. It can come in several varieties, but most are defined as either “term certain” or lifetime. In a term certain annuity, you pay a purchase price, and in exchange the company makes regular payments over a fixed period of time. This is generally seen as an investment product, with the returns based on the relationship between the contract’s purchase price and its payment schedule.
With a lifetime annuity, again you pay a purchase price for the contract. Then, when you retire, the life insurance company makes regular payments to you for the rest of your life. The amount of those payments is based on how much you spent to buy the annuity contract and your overall life expectancy.
Every lifetime annuity has up to four parties to the contract:
Issuer: The company that issued the contract and makes payments
Owner: The person who paid for and controls the contract
Annuitant: The natural person who receives payments under the contract
Beneficiary: The person who receives the contract’s death benefit payment
With the annuitant, we used the phrase “natural person.” This is a legal term meaning a human being as opposed to a corporation or other legal entity. In any lifetime annuity, the person who receives benefits under the contract must be an individual. A corporation, trust or other legal entity can own the contract but it cannot be the annuitant. This is because a lifetime annuity ends with one party’s death. Since a legal entity has no natural lifetime if a company could be both owner and annuitant the contract could theoretically continue forever.
With most annuities, the owner and the annuitant are the same people. This is the case when people purchases an annuity for their own use. They both own the contract and they receive benefits under it. However, it’s also possible for the owner and the annuitant to be different people. This is the case when one party pays for the contract but names a different person to receive payments under it.
There are two types of lifetime annuities:
These categories are defined by how the contract terminates. When you purchase an annuity, you can decide which type you want.
What Is an Annuitant-Driven Annuity?
In an annuitant-driven annuity, the contract ends with the death of the annuitant. These are usually straightforward contracts. When the annuitant dies, the contract pays its death benefit to the named beneficiary. Occasionally an annuitant-driven contract can raise complications.
If the owner of the contract is a corporation, trust or other legal entity, then the annuity always ends with the death of the annuitant. This is because, as noted above, the contract must have a natural termination. A legal entity cannot purchase an annuity that ends with its own death because it has no life expectancy.
When the owner and the annuitant are different people, an annuitant-driven contract must also terminate and pay its full distribution within five years of the owner’s death. This is true even if the annuitant is still alive due to the IRS’ “death of the owner” requirement.
What Is an Owner-Driven Annuity?
Most lifetime annuity contracts are owner-driven, because with most such contracts the owner and the recipient are the same people. An owner-driven contract terminates upon the death of the annuity’s owner. If the owner and the annuitant are different people and the annuitant dies, the owner can name a new annuitant to receive full payments until the contract ends.
This creates potential complications based on the relationship between the owner and the annuitant. The results of an owner-driven contract can fall out as follows:
The owner and annuitant are the same people, owner dies: The contract terminates and pays its death benefit to the beneficiary
The owner and annuitant are different people, owner dies: The contract terminates and pays its death benefit to the beneficiary
The owner and annuitant are different people, annuitant dies: The owner names a new annuitant to receive payments under the contract
Finally, an annuity contract can have what is known as “joint ownership.” This is when multiple people simultaneously own an annuity contract. That will lead to the following results:
Joint ownership, one owner dies: The surviving owner(s) can terminate the contract if they choose or take over full ownership
Joint ownership, Annuitant dies: The owners can name a new annuitant, including one of the joint owners if they choose
These rules remain the same even if one of the joint owners was the contract’s annuitant. If a joint owner dies under an owner-driven contract, the surviving owner(s) can either use this as a trigger to end the contract or can allow it to continue. If the owner who died was the annuitant, the remaining owner(s) can now name a new annuitant.
The Bottom Line
Annuities can be good investments for those looking for a fixed income in retirement. It’s important, however, to understand the various terms associated with the types of annuities if you’re thinking about moving forward. An owner-driven annuity is a lifetime annuity that ends with the death of the contract’s owner. An annuitant-driven annuity is a lifetime annuity that ends with the death of the contract recipient, or “annuitant.”
Tips for Retirement Planning
Lifetime annuities are a popular retirement investment but you may want to work with a financial advisor before deciding to move forward. Many advisors can help you make a financial plan or recommend the right investment options for your unique goals. Finding the right financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
In recent years investment professionals have increasingly questioned the value of annuities relative to growth in the S&P 500. You can look into our research to help you determine if an annuity is a good choice for you.
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