Period certain, cash refund and installment refund options compared

Each guarantee you add to a lifetime income annuity answers one question: if I die early, what comes back to my family? A period certain says "at least this many years of payments." An installment refund says "payments continue until you have received your premium back." A cash refund says "your heirs get the premium, less what was paid, in one lump sum." Each answer costs a slice of the monthly check, and the cost is not the same across the three.

This post compares them with one set of invented numbers so the trade-offs are visible. The payouts below are illustrations chosen for tidy arithmetic. They are not quotes, they will not match any insurer's actual figures, and the real gaps between options depend on age, sex where state law allows, and interest rates (see how annuity rates are set and why they move). Use the structure, not the amounts.

Why a guarantee lowers the check

A lifetime annuity pays more than a plain savings drawdown because of pooling. Everyone in the pool puts money in. Those who die early leave money behind that helps fund payments to those who live long. These are sometimes called mortality credits. A life-only annuity keeps the full pooling effect, which is why it pays the highest amount for the premium, and why it leaves nothing to heirs.

Every guarantee returns some of the money of those who die early to their families instead of leaving it in the pool. The insurer has less to spread across the survivors, so the check shrinks. The question is how much each guarantee takes back and how often it pays out.

Insurers call these choices payout options, or life income options, and the glossary entry on the period certain gives the short form. The wider question of how survivors are protected when the annuity covers two lives is in single life or joint-and-survivor: choosing how an income annuity pays. This post concentrates on one-life contracts and the heirs.

The illustrative contract

Say a hypothetical 70-year-old pays $200,000 for a single premium immediate annuity (Single premium immediate annuities (SPIAs): how they work) with payments starting next month. The invented monthly payments by option are:

Each cut is the difference from $1,250, and each percentage is that difference divided by $1,250. For example, $160 ÷ $1,250 = 12.8%.

The ordering matters more than the exact figures. Options that return more to heirs in more circumstances pay less. A 20-year period certain guarantees 240 payments no matter how long you live, which promises more than a 10-year one, and it costs more.

How each option works

Life with period certain. The insurer pays you for life, but if you die before the period ends, your beneficiary receives the remaining payments for the rest of the period. Common periods are 5, 10, 15 and 20 years. After the period ends, the guarantee is spent; it gives your heirs nothing at all if you die in year 11 under a 10-year certain. Some contracts let the beneficiary take the remaining payments as a discounted lump sum instead, and the discount rate used matters, so ask. The period is counted from the first payment, not from your age.

Life with installment refund. The insurer pays you for life. If you die before the payments you received add up to the premium, the beneficiary keeps receiving the same monthly payment until the total paid, to you and the beneficiary together, equals the premium. If you outlive the point where you have received your premium back, the guarantee is spent and pays nothing.

Life with cash refund. This is like the installment refund, but the balance is paid in one lump sum: the premium minus the payments already made. Because the insurer pays out sooner, which means it loses the chance to earn interest on the balance while paying it in installments, the cash refund usually costs a bit more than the installment refund, as in the table above.

In all three, the guarantee covers a bounded period: the beneficiary gets something only if the death happens early enough. After that, you are back to a life-only contract with a smaller check.

What heirs receive: three outcomes

Here is what each option pays to heirs at three possible dates of death, and what the owner collected. The amounts count only the annuity.

Death after 5 years (60 payments).

Under the installment refund, the $129,800 would arrive as $1,170 a month for 110 months, with a final smaller payment of $1,100 (110 × $1,170 = $128,700, and $129,800 − $128,700 = $1,100).

Death after 15 years (180 payments).

Death after 25 years (300 payments).

Look at the three tables together. At year 5, every guarantee does something for the family and the life-only choice does not. At year 15, only the 20-year period certain still does. At year 25, the guarantees have done nothing and the life-only owner has collected $48,000 more than the 20-year certain owner ($375,000 − $327,000), simply because of the higher monthly check.

That is the whole trade in one sentence: the guarantee is insurance against early death that you pay for with a smaller check every month, whether you die early or not.

What the protection costs each year

It helps to turn the cuts into yearly dollars and ask what they add up to if the guarantee is never used.

Each yearly cut is the monthly cut times 12 (for the 10-year certain, $55 × 12 = $660), and each total is that yearly figure times the number of years. Set these against the most each guarantee can pay. The 10-year certain can pay at most 120 payments of $1,195, or $143,400, to heirs if death comes right after purchase. The 20-year certain can pay at most 240 payments of $1,090, or $261,600. So the buyer is paying $660 or $1,920 a year for the chance of a payout that is very unlikely to be at its maximum and becomes smaller every year that passes.

This is the same logic as any insurance. The right question is not whether the guarantee will pay, but whether the family would be harmed enough by an early death with nothing coming back to justify a certain, smaller loss. For a household that relies on other assets and income, the answer may be no. For a household in which the annuity uses most of the savings, it may be yes.

When the "refund" is just your own money coming back

The cash and installment refunds are easy to misread. A refund option does not add value to the contract. It guarantees that at least the premium comes back in total, which means the heirs are receiving your own money, not an extra benefit. Life-only is, in a sense, a bet that you will beat the pool. The refund is a promise that you cannot lose your whole premium to the pool.

Compare that with the period certain, which can pay more than the premium to heirs, as the 20-year column shows ($261,600 in total if death comes at year 5). A longer period certain has a larger potential payout and a larger price.

Reading the options against your own situation

Four questions sort most buyers toward an option before any quote arrives.

1. Who else depends on this money? If a spouse or an adult dependent would be hurt by losing the premium, a guarantee or a joint option is worth pricing. If nobody depends on it, life only becomes more attractive.
2. How large a share of savings is going in? Putting 20% of savings into a life-only annuity leaves 80% for heirs. Putting in 80% changes the picture and makes a refund feature more important.
3. How is your health? Health usually does not change the price of an ordinary income annuity. If you have a condition that makes an early death more likely, a guarantee is worth more to you than to the average buyer at that price. If your health is excellent and your family is long-lived, the guarantee is worth less, because the pool is pricing an average person.
4. What would you regret? Some people would regret leaving nothing after an early death more than they would regret a smaller check for decades. Others feel the opposite. Both are legitimate, and the numbers cannot pick for you.

Who each option tends to suit

There is no best option, only a best fit for a situation.

Life only tends to suit someone with no dependents who will rely on the income, who has other assets to leave to heirs, and who wants the highest check. It is also the one that most directly insures against outliving savings. The risk is the early-death outcome with nothing for anyone. It tends to suit poorly someone who would regret leaving no estate from a large share of savings.

Short period certain (5 or 10 years) tends to suit someone who wants a modest safety net against dying right after purchase, for example in the first few years when a large share of the premium is still "unreturned." The price is small, 4.4% in the example. A 10-year certain also gives a defined window in which a beneficiary does not lose the entire investment.

Long period certain (15 or 20 years) tends to suit someone who is relatively young for an income annuity, such as a 60-year-old, and wants the contract to function as a floor for a known number of years. It costs more, and its value to heirs falls the longer you live. It can also function as a hedge against the fear of buying an annuity at all.

Installment refund tends to suit someone who specifically wants the premium protected rather than a fixed number of years. If you expect to live long, the guarantee will go unused, but you know the downside is limited.

Cash refund tends to suit the same person and a family that would prefer a lump sum, for example if there is a mortgage to pay or the heirs need the funds at once. Note that the lump sum can raise tax questions, since the heirs receive it in a single year.

Taxes and heirs

How the heirs are taxed depends on how the annuity was bought. For an annuity bought with after-tax money, each payment to the owner has a tax-free part and a taxable part, set by the exclusion ratio. If the owner dies before recovering the full cost, the unrecovered amount can generally be deducted on the final return. Payments or a refund to the beneficiary are subject to their own rules, and the precise treatment depends on the contract and the facts. For an annuity bought with IRA money, payments to heirs are generally taxable. how annuities are taxed gives the overview, and a tax professional should confirm yours.

The beneficiary matters for practical reasons too. The refund or remaining payments go to the person named on the contract, not to whoever the will names. Check the form (annuity beneficiaries and inherited annuity options and what happens to an annuity when you die cover the mechanics), name a contingent beneficiary and update the form after life changes.

Alternatives to buying a guarantee

An option that returns money to heirs is one way to protect them. There are others, and the comparison is worth making.

• Spend less on the annuity and keep the rest. If you buy a life-only annuity with half your savings, the other half can go to heirs, and the annuity covers essentials.
• Use life insurance. A life insurance policy can leave a legacy at an exact amount, and the annuity can then be life-only. Whether that is cheaper than the guarantee depends on your age and health, and a policy requires underwriting.
• Buy in stages. Buying annuities over several years keeps part of the savings flexible.
• Choose a joint option if the worry is a spouse. That is a different guarantee, covered in the post on single life or joint-and-survivor: choosing how an income annuity pays.

Questions to ask before choosing

1. How long is the guarantee counted from, and does it end on a stated date or when the premium is repaid?
2. If I die, does my beneficiary choose between continuing payments and a lump sum, and what discount rate would the lump sum use?
3. What happens if the beneficiary has died or cannot be found?
4. Can I see the quote for each option on the same premium, same start date, in writing?
5. Is the payment fixed, or does it include a cost-of-living adjustment?
6. How is the refund taxed for my kind of annuity?
7. What is the free-look period, and what exactly is refunded if I cancel?

Run the options against the annuity payout calculator for a first look, then ask for actual written quotes. For common mistakes in the choice, see mistakes people make when they turn an annuity into income.

Key takeaways

• A period certain guarantees a number of years of payments, an installment refund guarantees the premium comes back in installments, and a cash refund guarantees it as a lump sum.
• Every guarantee lowers the monthly check; in the example the cut ranged from 4.4% for a 10-year certain to 12.8% for a 20-year certain.
• The guarantees pay heirs only if death comes early; after the period or premium is repaid, they pay nothing, and you are left with a lower check.
• A refund returns your own money, while a long period certain can return more than the premium.
• Compare written quotes for the same premium and consider alternatives such as buying less or using life insurance for a legacy.