One of the biggest reasons people buy annuities is the ability to turn savings into income that’s guaranteed to last for life, no matter how long that turns out to be. Here’s the mechanism behind how that actually works.

Pooling and mortality credits

Insurance companies collect premiums from a large pool of annuity holders. Statistically, some people will live longer than average and some will live shorter than average. Because the insurer is managing risk across the whole pool rather than any one individual, it can guarantee lifetime payments to everyone. This is sometimes called “mortality credits,” where funds from those with shorter lifespans help support payments to those who live longer. It’s the same underlying principle that made traditional pensions possible.

How payments are calculated

Your payment amount is typically based on your account value (or a separate “income base” if you have an income rider), your age when payments begin, your gender in some cases, and the payout option you select, such as single life, joint life (covering a spouse too), or a period-certain guarantee.

Payout options

• Single life: the highest payment amount, but payments stop when you pass away.
• Joint life: a somewhat lower payment, but continues for as long as either you or your spouse is living.
• Period certain: guarantees payments for a minimum number of years even if you pass away early, with remaining payments going to a beneficiary.

The trade-off across all of these options is the same: more guarantees and longer coverage generally mean a smaller payment per period. Comparing the actual numbers for your age and goals is the only way to know what a specific option would pay.

This article is educational and general in nature. It isn’t personalized financial advice. All guarantees are subject to the claims-paying ability of the issuing insurance company.