The Correct Answer and Explanation is:
The correct answer is income period.
An annuity is a financial contract with an insurance company where an individual pays a lump sum, known as the principal, in exchange for a series of regular payments over time. For a fixed immediate annuity, these payments begin shortly after the principal is paid and the amount of each payment is guaranteed to be the same.
The calculation of this payment amount is based on three primary factors:
- Principal: This is the initial amount of money used to purchase the annuity. A larger principal will naturally result in a larger payment amount, all other factors being equal.
- Interest: The insurance company credits the principal with a guaranteed interest rate. This interest growth contributes to the total pool of money that will be paid out, thus influencing the size of the payments.
- Income Period: This is the duration over which the payments will be made. The income period is a critical component of the calculation because it determines how long the principal and its accumulated interest must last. A shorter income period, such as a 10-year certain plan, will result in higher individual payments than a longer period, like a 20-year plan or a life annuity for a younger person. The insurance company essentially amortizes the total sum over this defined period.
The other options are less accurate. A cash refund and a death benefit are payout features that specify what happens if the annuitant dies before receiving a certain amount. While choosing such a feature will affect the payment calculation (typically lowering it to cover the insurer’s increased risk), the fundamental variable they influence is the potential length and total value of the payout, which is encapsulated by the concept of the income period. A surrender charge is a fee for withdrawing money early from a deferred annuity and is not a factor in determining the payment amount for an immediate annuity.
