Definition of Cash Refund Annuity

An annuity has an initial accumulation phase in which the owner makes one or more premium payments to the provider. The amount the owner kicks in minus the amount taken out is the cost basis. In a variable annuity, the premiums can be invested in several ways, including interest rate indexes, stock index funds, mutual funds, stocks and bonds. The annuity’s cash value is the sum of the cost basis and the investment returns, minus any money withdrawn or paid in fees. On the annuity date, the owner either takes the cash value as a lump sum payment or annuitizes the contract and receive a stream of payments for the agreed period.

In some ways, a life annuity is a gamble. The owner is betting that she’ll live long enough to receive at least the money paid in, and perhaps a lot more. The contract provider is taking the opposite bet. A cash refund annuity takes some of the risk out of the owner's bet. By definition, a cash refund annuity is a contract that forks over the remaining cost basis to a beneficiary when the owner dies. For example, if the owner paid in $50,000 and dies after receiving only $5,000 in annuity payments, you, as the beneficiary, receive a $45,000 refund as a lump sum payment. By contrast, an installment refund annuity shells out the refund in a series of payments.

Receiving the cost basis refund, while reassuring, might seem to some like weak tea. If an owner is willing to cough up higher premiums, she can purchase a stepped-up death benefit that exceeds the basic refund amount. This death benefit might be a fixed amount or might depend on the annuity’s cash value as of a certain date. Of course, the higher premium paid for a stepped-up death benefit leaves less money available for investment by the annuity.

Annuities are by no means risk-free. Owners and beneficiaries have only the word of the insurance company that it will have enough money to make future payments. Ratings companies evaluate the financial strength of insurers to help consumers evaluate the probabilities that the provider will live up to its promises. Another risk with variable annuities is that the investment performance will cause the owner to lose money, reducing or eliminating annuity income. Finally, there is the risk that the owner needs to cash out the annuity before the annuity date. The insurance company might slap the owner with a surrender fee that might exceed 10 percent, especially during the early years of the contract.