## How does an annuity with return of premium work?

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Topic Author
antiqueman
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Joined: Thu Mar 12, 2009 5:22 pm

### How does an annuity with return of premium work?

Can one or more of you explain how an annuity with return of premium works?

I realize that if the annuitant dies before all the premium has been used, then the remaining amount of the premium will be returned .

The question is " How is it determine what amount of premium is left to return ?"

If a person buys a life annuity , with unused premium returned, during the period the annuitant' life does the insurance company simply use the premium for the first "X" years until the premium is exhausted ? Or is it combination of the premium, interest rate and mortality credits which would extend the years remaining premiums are available to be returned if annuitant dies?

Thank you.

Grt2bOutdoors
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Location: New York

### Re: How does an annuity with return of premium work?

No, it’s simple math. For the purchaser, if premium is \$100k and monthly annuity is \$2000. Let’s say you start annuity and die at the end of year 2. Your heirs are entitled to 52k back. The interest and mortality credits are built into the monthly \$2k figure you were receiving before you kicked the bucket.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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### Re: How does an annuity with return of premium work?

antiqueman wrote:
Tue Dec 04, 2018 5:31 pm
How does an annuity with return of premium work?
Expensively.

Topic Author
antiqueman
Posts: 498
Joined: Thu Mar 12, 2009 5:22 pm

### Re: How does an annuity with return of premium work?

Thank you.

I have a few additional questions:

Other than the fact that if you select a return of premium the monthly payout amount will be less, and if part of the premium is refunded you will have lost the compounding value of that amount over the year, are there other downsides?

Would an annuity illustration show the year all the premium would be exhausted?

Thanks

Dottie57
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### Re: How does an annuity with return of premium work?

antiqueman wrote:
Tue Dec 04, 2018 6:19 pm
Thank you.

I have a few additional questions:

Other than the fact that if you select a return of premium the monthly payout amount will be less, and if part of the premium is refunded you will have lost the compounding value of that amount over the year, are there other downsides?

Would an annuity illustration show the year all the premium would be exhausted?

Thanks

I think Grt2bOutdoors nailed it. The total of all payments is counted as premium.

CppCoder
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### Re: How does an annuity with return of premium work?

antiqueman wrote:
Tue Dec 04, 2018 6:19 pm
Other than the fact that if you select a return of premium the monthly payout amount will be less, and if part of the premium is refunded you will have lost the compounding value of that amount over the year, are there other downsides?
I don't understand your question. A simple annuity is not an investment with any kind of compounding return; it is an insurance product. It has an actuarial present value that equals the discounted future cash flow streams multiplied by the statistical likelihood of payment. A return of principal is simply a certain period defined by the principal divided by the payment rather than a predefined calendar time period. What is it that you are trying to deduce?

randomguy
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### Re: How does an annuity with return of premium work?

CppCoder wrote:
Tue Dec 04, 2018 7:32 pm
antiqueman wrote:
Tue Dec 04, 2018 6:19 pm
Other than the fact that if you select a return of premium the monthly payout amount will be less, and if part of the premium is refunded you will have lost the compounding value of that amount over the year, are there other downsides?
I don't understand your question. A simple annuity is not an investment with any kind of compounding return; it is an insurance product. It has an actuarial present value that equals the discounted future cash flow streams multiplied by the statistical likelihood of payment. A return of principal is simply a certain period defined by the principal divided by the payment rather than a predefined calendar time period. What is it that you are trying to deduce?
Taxation of benefits is all I can think of.

But yes that is the downside. Imagine you have an annuity you pay 1 million for and you get 100k/year. You die in year 10. You end up getting 1 million dollars. Insurance company gets 300k (i.e. the interest payments over those 10 years). The insurance company uses the 300k to pay expenses and to fund mortality credits. The people that die early subsidize the ones that life longer. A certain period makes the winners (people who live longer than expected) get less money (they paid for insurance they didn't need) and the losers (the guys that die years ahead of schedule) get more.

GibsonL6s
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### Re: How does an annuity with return of premium work?

antiqueman wrote:
Tue Dec 04, 2018 5:31 pm
Can one or more of you explain how an annuity with return of premium works?

I realize that if the annuitant dies before all the premium has been used, then the remaining amount of the premium will be returned .

The question is " How is it determine what amount of premium is left to return ?"

If a person buys a life annuity , with unused premium returned, during the period the annuitant' life does the insurance company simply use the premium for the first "X" years until the premium is exhausted ? Or is it combination of the premium, interest rate and mortality credits which would extend the years remaining premiums are available to be returned if annuitant dies?

Thank you.
A 65 year old man investing \$100,000 in an annuity could get a life only payment of \$554 a month or a life with premium refund of \$514. If he dies in month one in the first scenario his heirs get nothing, in scenario two they get \$99,486. The lower payment is in essence the cost of another layer of insurance. In the first scenario if the annuitant lives 5 years, the return is negative 37%, in the second it is zero. Live 30 years and the yields are 5.28 % and 4.62%

Topic Author
antiqueman
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Joined: Thu Mar 12, 2009 5:22 pm

### Re: How does an annuity with return of premium work?

A 65 year old man investing \$100,000 in an annuity could get a life [b]only [/b]payment of \$554 a month or a life with premium refund of \$514. If he dies in month one in the first scenario his heirs get nothing, in scenario two they get \$99,486. The lower payment is in essence the cost of another layer of insurance. In the first scenario if the annuitant lives 5 years, the return is negative 37%, in the second it is zero. Live 30 years and the yields are 5.28 % and 4.62%
[/quote]

I am the OP.

The above response touches on my question. I could have stated the question better initially so I will try again.

Since there appears to be little difference in the monthly benefit between a life only and life with return of premium ( as noted in the above response. There is only a \$10.00 a month difference between life only and life with refund). Why would an annuitant not purchase the return of premium option when there is only a small difference between life only and life with return of premium. Would I really miss \$10.00 a month , especially after taxes?

It is my impression from reviewing this forum for a number of years, that SPIA is the only annuity recommended. I don't recall there being suggestions that one purchase a SPIA with return of unused premium. Why is that?

Thanks.

nedsaid
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Joined: Fri Nov 23, 2012 12:33 pm

### Re: How does an annuity with return of premium work?

antiqueman wrote:
Wed Dec 05, 2018 7:22 pm
gibsonL6s wrote: A 65 year old man investing \$100,000 in an annuity could get a life only payment of \$554 a month or a life with premium refund of \$514. If he dies in month one in the first scenario his heirs get nothing, in scenario two they get \$99,486. The lower payment is in essence the cost of another layer of insurance. In the first scenario if the annuitant lives 5 years, the return is negative 37%, in the second it is zero. Live 30 years and the yields are 5.28 % and 4.62%

I am the OP.

The above response touches on my question. I could have stated the question better initially so I will try again.

Since there appears to be little difference in the monthly benefit between a life only and life with return of premium ( as noted in the above response. There is only a \$10.00 a month difference between life only and life with refund). Why would an annuitant not purchase the return of premium option when there is only a small difference between life only and life with return of premium. Would I really miss \$10.00 a month , especially after taxes?

It is my impression from reviewing this forum for a number of years, that SPIA is the only annuity recommended. I don't recall there being suggestions that one purchase a SPIA with return of unused premium. Why is that?

Thanks.
Well a Single Premium Annuity is for the 65 year old man is an annuity for his life only. He is turning over the \$100,000 in exchange for \$554 a month for the rest of his life. Essentially he has a bet with the insurance company, for the annuitant to "win" the bet, he has to live longer than the breakeven point, probably about 18 years. If he dies before then, too bad, even if he dies after buying the annuity but before receiving his first payment.

If that man buys an SPIA for life only with return of premium, he is buying two products. He will receive the \$514 a month for the rest of his life. The difference between the \$554 and the \$514 is to pay for a decreasing term policy for the \$100,000 minus all annuity payments until time of death. So there is an annuity portion and a death benefit portion. In this example, you are paying the \$40 a month for decreasing term insurance.

Were I to buy an annuity, I would probably have either a return of premium provision or a period certain period, lets say 10 years, on the annuity. So let's say I buy a 10 year period certain rider on the annuity and I die 5 years into receiving annuity payments, my heirs would receive the remaining 5 years of payments that were guaranteed.

Why is it that Bogleheads have not recommended an SPIA with a return of premium or a period certain rider? I don't know. I would say this, I think someone buying a Single Premium Immediate Annuity should think long and hard about this. I think I would buy the rider.
A fool and his money are good for business.

stlutz
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### Re: How does an annuity with return of premium work?

Compare the cost of buying the rider at age 65 vs. say, age 80.

If a couple buys an annuity at age 65, odds are very high that one of them will live long enough to get their full premium back, which makes the rider pretty cheap. A single male buying an annuity at 80, the rider is quite expensive.

I agree that with nedsaid that it's probably worth it when buying an annuity at a younger age given the low cost.

nedsaid
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Joined: Fri Nov 23, 2012 12:33 pm

### Re: How does an annuity with return of premium work?

Probably what I would do is buy a period certain of 10 years. That seems to be cheaper than the return of premium because you are in effect buying term insurance for 10 years rather than about 18. What I care about is that I have guaranteed income for the rest of my life, a secondary consideration is that my heirs would receive at least something if I died soon after receiving payments. This seems like a reasonable compromise.

The return of premium costs in our example about \$40 a month, 10 year certain is less than that, maybe \$20?
A fool and his money are good for business.

Topic Author
antiqueman
Posts: 498
Joined: Thu Mar 12, 2009 5:22 pm

### Re: How does an annuity with return of premium work?

[quote=nedsaid post_id=4244926 time=1544064472 user_id=41182]
Probably what I would do is buy a period certain of 10 years. That seems to be cheaper than the return of premium because you are in effect buying term insurance for 10 years rather than about 18. What I care about is that I have guaranteed income for the rest of my life, a secondary consideration is that my heirs would receive at least something if I died soon after receiving payments. This seems like a reasonable compromise.

The return of premium costs in our example about \$40 a month, 10 year certain is less than that, maybe \$20?
[/quote]

Thank you Nedsaid and Stultz> Your responses helped me clarify the situation.