Martha and Mark are a married couple in their late 60s. They are concerned because Mark's pension will dry up when he passes away, which would force Martha to drastically reduce her standard of living. Although their assets probably will be sufficient to support Martha for the rest of her life, they do not want to tap them unless absolutely necessary. Right now, the pension is substantial enough to supply most of their needs, leaving their other assets to grow and eventually pass to their beloved children.
Is there a way to insure against the risk of Mark's early death and the loss of his pension income without breaking the bank on a high-cost permanent life insurance policy on Mark's life?
How about a reversionary annuity?
Life insurance is often the go-to product in situations similar to Martha and Mark's, but in many cases, insurance is out of the question. A term policy will not work because it will lapse, and a permanent policy may not be feasible because the premiums are normally high. And life insurance may be out of the question because of the insured's health or age.
A reversionary annuity may be just what a couple like Martha and Mark need to make up the income shortfall that will come after Mark's death. Reversionary annuities can be useful in any situation where one person will require regular income after the death of another, for instance:
- Where the payout on a spouse's annuity or pension pays out only over his lifetime.
- Where the spouse who is likely to live longer will be unable to live comfortably without the other spouse's Social Security or other payments that cease at the time of death.
- Where a disabled child will depend on a parent for lifetime income.
- Where a low-cost alternative to a buy-sell agreement for business owners is needed.
What exactly is a reversionary annuity?
A reversionary annuity is essentially a life insurance policy coupled with an immediate annuity. When the insured dies, the death benefit is used to fund an immediate annuity on the beneficiary's life. Unlike a life insurance policy, the product offers only a predetermined life income option for the beneficiary; there is no lump-sum payout at the death of the insured.
Because of its low cost when compared to permanent insurance, reversionary insurance may also make sense for individuals with medical problems or a shorter life expectancy that makes life insurance unaffordable. For older couples, a reversionary annuity may be affordable even if a life insurance policy is not, because the beneficiary's relatively short life expectancy decreases the cost of the policy due to the likelihood that it will not pay out over an extended period.
Riders, benefits and options
Reversionary annuities are generally inflexible; if the insured's or beneficiary's needs change, they are out of luck. In their most basic form, reversionary annuities simply pay a fixed monthly sum to the beneficiary after the insured's death. If the beneficiary dies before the insured, payments into the product cease and the insured is left without value or benefits from the policy.
However, there are a number of riders and options that can vary that standard. For instance, instead of a "fixed monthly sum," an inflation-protection option can be purchased for an additional premium. One such option, the "3 percent increasing option" increases the monthly payout by 3 percent on every policy anniversary date. Another option, the "5 percent increasing option" increases the monthly payout by 5 percent on each anniversary of the first monthly benefit payment to the beneficiary.
There are also options for ensuring that payments will continue at the insured's death even if the beneficiary pre-deceases the insured. A premium return option will return premium payments to the insured if the beneficiary predeceases the insured. Simultaneous death benefit and accelerated first-year benefit riders are also available.
Taxation of distributions from a reversionary annuity
