Mortality credits and period certain
are two important concepts not to overlook when discussing the features of a
life annuity product. Many people aren’t
familiar with these essential terms.
Consider this: Doug and Helen walk into
a bank. Doug is 20 years old and Helen is 70
years old. They both tell the bank officer that they have $100,000 to invest
and want to take the most interest they can get for the rest of their
lifetimes.
Because of her age, Helen has a
distinct advantage in her number of choices. Helen could simply put
$100,000 in a bank CD and take the current interest rate of 2% on a five-year
CD.
However, Helen also has the option of
taking a life
annuity1 or a life annuity with period
certain2 instead of a CD. A life annuity would pay her an
income for as long as she’s alive. A life
annuity with period certain means that if she dies before a
stated period (usually 20 years), payments would continue to be made to her
heir(s) for the remainder of the stated period (in this case, we’ll use 20
years).
Mortality credits play an important
part in this decision. According to Annuity
Digest3, mortality credits are also known as the mortality
yield. Simply put, mortality credits are the reallocation of
contributions of those who die to those who survive. With a participating
annuity, premiums paid by those who die earlier than expected contribute to
gains of the overall pool and provide a higher yield or credit to survivors
than could be achieved through individual investments outside of the pool. The
mortality credit increases significantly with age and hedges longevity risk,
often creating a return that would be impossible to match in the broader
financial markets. The older you are,
and the longer you live, the more mortality credits you can get paid.
For example, let’s assume that out of
100 people that are 70 years old, 10 of them die in the next year. Those 10
people had contributed $100,000 or a grand total of $1 million (in addition to
interest). That $1 million is now divided among the 90 surviving people.
So that $1 million goes above and beyond the interest that was paid. The 90
survivors will get $11,111.
Now, the question becomes, “what if
you’re one of those unlucky 10 who pass away?” That’s where period
certain comes in and can offset things. A life annuity with
period certain simply states that your income will continue to be paid for as long
as you and/or your spouse are living. If you pass away before this period
of time, your heirs will receive the income for the duration of the specified period
certain.
In this illustration, we're using a
$100,000 investment with a 20-year period certain. If the product
pays income of $5,600 a year, this means that in the worst-case scenario over
the 20 years, the individual or their heir(s) would receive $112,000 back in
payments.
As you can see, you do not want to
overlook mortality credits and period certain when discussing the features of a
life annuity product. The mortality
credit often creates a return that would be impossible to match in the broader
financial markets.
2 "Period Certain” Investopedia; http://www.investopedia.com/terms/p/periodcertain.asp#axzz2JSyoBnXg
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appropriate for you, consult with your financial, tax or legal
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Annuities are long-term investment
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