A life option is one of many settlement options available to the owner of an annuity, in which an actuary-determined income is paid to a recipient, called an annuitant, for the annuitant's lifetime, usually on a monthly basis. An annuity is a contract entered into with an insurance company to pay a guaranteed income to an annuitant, usually beginning at some point in the future, which is a "deferred annuity," or sometimes immediately upon drawing up the contract, which is an "immediate annuity." The amount of the income is based upon a number of factors, including the annuitant's age at the commencement of the payments and the value of the annuity at that time.
Annuities grow in value during their accumulation phase, which is the period between the annuity contract's origination and the commencement of income payments, where the entire value of the annuity is converted to the guaranteed monthly income stream in a process called annuitization. For variable annuities, the premium(s) paid for the annuity are invested, and the accumulation or loss of value is based strictly on the investments' performance. Fixed annuities pay a flat interest rate set by the insurance company, and indexed annuities' interest rates are linked to the movement of market equity indexes, like the Standard & Poor's 500, although when the linked index declines in value, indexed annuities don't earn any interest, although there's no loss of principal.
When the owner decides to convert an annuity to a guaranteed income stream, or to annuitize, several options are available. The life option converts the annuity's value to monthly payments to the annuitant — usually the owner, but it can be another person — based on the annuity's value and the annuitant's life expectancy. While a life option must continue to make those monthly payments regardless of how long the annuitant lives, even after the value of the annuity has been exhausted, a very real drawback is that if the annuitant dies before the exhaustion of the annuity's value, that value reverts to the insurance company. Due to this very significant drawback, there are several alternatives to a life option that will guarantee that the full amount of the annuity actually is paid out, either to the annuitant or to a beneficiary.
The “joint and survivor” option pays the income to a couple and continues paying until both have died, and a “life with period certain” option pays the income for at least a fixed period of time, usually five or ten years. If the annuitant outlives the period certain, payments stop upon death, but if death precedes the period certain, payments will continue to a named beneficiary until the expiration of that period. Whether the payout choice is a life option or one of the alternatives, the choice is irrevocable and must thus be carefully considered.
Annuities are popular instruments for retirement savings, and the settlement options offer the peace of mind of knowing that one's savings cannot be outlived. Most annuitants choose settlement options other than the life option, however, because of the potential drawbacks associated with that choice.
