An annuity contract is an agreement whereby a purchaser (usually referred to as the "policy owner") pays a lump-sum amount of money (the "purchase price" or the "principal") to a company (usually referred to as the "policy issuer") in return for the issuer's promise to make periodic payments (the "annuity payments") to the policy owner for a specified period of time (the "annuitization period"). The annuitization period is usually measured by the life span of a specific individual (the "annuitant"). The annuitant is usually (but does not have to be) the policy owner.
Annuity contracts may be "current" or "deferred" and may be "fixed" or "variable".
A current annuity contract requires the annuity payments to begin immediately. A deferred annuity contract requires the annuity payments to begin at some future time (the "annuitization date"), typically when the annuitant reaches his/her anticipated retirement age, or some other age when additional income may be desirable.
In a fixed annuity contract (sometimes known as a guaranteed annuity), the issuer guarantees that each annuity payment will be a pre-specified fixed amount.
In a variable annuity contract, the annuity payments will vary according to the investment performance of the principal.
The most common form of annuity contract is a deferred variable annuity contract. Typically, the issuer accepts the owner's purchase payment and invests these funds to generate income and appreciation of the principal. On the specified future annuitization date, the issuer begins making annuity payments to the owner. The issuer will divide the total value of the principal (including any accrued income and appreciation) by the expected number of annuity payments to be made over the annuitization period in order to determine the amount of each annuity payment. Typically, the annuitization period is the annuitant's remaining life, and the issuer will rely on actuarial tables to estimate the annuitization period. The issuer may revise its calculations periodically, and the annuity payments may be adjusted to reflect changes in actuarial life span and investment performance. Upon the death of the annuitant, the issuer will pay any remaining principal to the owner's beneficiaries, pre-specified in the contract.
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