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Taking Care of Mom and Dad: When...and How...an Annuity Pays

If your parents pay for an annuity in a single payment, the benefits may begin immediately (typically, within a month) or they may be deferred. If an annuity is purchased with a series of periodic payments, then the benefits will be deferred until all payments have been made. (This second kind of annuity is commonly called a periodic-payment deferred annuity.)

There are two periods of time associated with an annuity: the accumulation period and the annuity or benefit period.

The accumulation period is the time during which your parents make contributions or payments to the annuity. The interest paid on money contributed during this time is tax-deferred. That interest will be taxed eventually -- but not until they begin to receive the benefits. The contributions are placed in what is called a separate account.

The annuity period is the period following the accumulation of their payments (principal and interest), during which annuity benefits are received. Your parents can usually choose to receive income payments monthly, quarterly, semiannually or annually.

A variable annuity poses several other issues.

As evidence of participation in the separate account, units of the trust are issued. During the accumulation period, these units are identified as accumulation units. Both the number of units and the value of these units will vary in accordance with the amount of premium payments made and the subsequent performance of the separate account.

Example: Jack invests $100 per month in his variable annuity. On the day the insurance company receives his $100 payment, the value of an accumulation unit is $10. Thus, Jack is credited with 10 additional accumulation units.

When your parents reach the annuity period, the accumulation units are converted to annuity units, and the number of annuity units remains constant, since no further money is being contributed.

While the number of annuity units remains constant, their value varies in accordance with the daily performance of the separate account. Accordingly, during the annuity period, the size of the monthly benefit check will vary depending on the value of the annuity units at the time the check is issued.

Annuity settlement options determine when and how the annuity will pay -- and to whom. Even if your parents elect one option when they buy an annuity, it may (and probably will) be changed at the annuity period to reflect your parents' changing needs. (These changes usually have something to do with retirement or the death of a spouse.) Both variable and fixed annuities offer the same options for settlement of the contract.

The amount of money available during the annuity period is determined by the annuity option selected, the amount of money your parents have accumulated and their life expectancy.

A life-only or straight-life option provides for the payment of annuity benefits for your parents' lifetime -- with no further payment following their death. There is a risk involved -- in that they must live long enough once the annuity period begins to collect the full value. If they die shortly after benefits begin, the insurance company keeps the balance of the unpaid benefits. This option will pay the highest amount of monthly income, because it is based only on life expectancy, with no further payments after the death of one of your parents.

A refund option will pay your parents for life, too -- but, if they die shortly after the annuity period begins, there may be a refund of any undistributed principal or the cost of the annuity. The refund may take the form of continued monthly installments or it may be in one lump sum (a cash refund annuity). This option assures them that the full purchase price of the annuity will be paid out to someone other than the company issuing the annuity. If they live well beyond the average life expectancy, then all of their investment in the annuity probably will have been paid and there will be no refund.

Life with period certain is basically a straight-life annuity with an extra guarantee for a certain period of time. (This is the most popular choice for payment option.) It provides for the payment of annuity benefits for, let's say, your dad's lifetime but, if he dies within the predetermined period of time, annuity payments will be continued to a survivor, such as your mom, for the balance of that period.

The period certain can be just about any length of time -- five, 10, 15 or 20 years. Most often, the period selected is 10 years, because 10 years is approximately the average life expectancy of a male who retires at age 65. Thus, if your dad retires at age 65, selects life with 10 years certain and dies at age 70, his survivor will receive the monthly annuity payments for the balance of the period certain (five more years).

The joint-survivor option provides benefits for one's lifetime and the life of the survivor. So if your dad has the policy, a stated monthly amount is paid to him and, upon his death, the same or a lesser amount is paid for the lifetime of the survivor -- your mom. The joint-survivor option is usually 100 percent, two-thirds or one-half of the baseline benefit.

The joint-survivor annuity option should be distinguished from a joint-life annuity, which covers two or more annuitants and provides monthly income to each of them until one dies. Following the first death, all income benefits cease.

If your parents turn $200,000 over to an insurance company and name each other as beneficiary, when one dies the annuity remains for the survivor. The size of payments may vary -- from company to company -- depending on each insurer's estimate of their life expectancies and how much each felt it could earn investing their money.

If you're really worried that your parents will outlive their money, you may want to consider a deferred annuity. For example, if your parents purchase an annuity deferred to age 85, they are insuring the risk that they run out of money before reaching age 85. These annuities pay nothing if they die before age 85, so they are much cheaper than the other annuities. Payments commence when your parents reach age 85. Of course, they have to pay for these annuities long before they mature, thus taking money out of their portfolio that they won't see for some time. But these kinds of annuities can be worthwhile -- especially if you're concerned about their ability to stay afloat in their later years.

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