Annuities are useful financial vehicles for securing your standard of living during retirement. They come in many forms, including fixed, fixed-indexed, and variable, and can be annuitized at different times depending on your contract.
A split annuity strategy allows you to have income now from one type of annuity and income later through a different annuity. Below we’ll cover what a split annuity is, how it works, and how to decide if this strategy is right for you.
What Is a Split Annuity?
A split annuity is a strategy that combines contracts for immediate and deferred annuities. In this case, you buy a single premium immediate annuity (SPIA) with a period-certain payout schedule. This means the SPIA will only pay out for a predetermined period of time, such as 10 years, instead of paying lifetime income.
At the same time you buy the SPIA, you also purchase a deferred annuity. This second annuity will accumulate interest and grow in value during the period you collect payments from the SPIA.
The strategy typically works by choosing a maturity date on the deferred annuity that matches the length of the SPIA payout. For example, you can choose a 10-year SPIA payout and a 10-year deferred annuity. That way, you begin receiving income from the deferred annuity at the end of the SPIA payout term.
If you purchase enough of the deferred annuity, you can potentially restore your original principal amount through compounding interest.
Note: All guarantees are subject to the claims-paying ability of the insurer.
How Split Annuities Work
The main reason to use a split annuity is to turn your retirement contributions into income at different times. You get a consistent income that starts now plus another income later that can last the rest of your life depending on the contract.
The immediate annuity portion is helpful if you’re just about to enter retirement since you don’t have to wait to receive an income. The deferred annuity builds your investment on a tax-deferred basis during that time and provides regular income once the first annuity ends.
Different types of annuities offer different growth potentials you can use in your strategy. Fixed annuities grow at a rate set by the insurance company, while fixed-indexed annuities grow based on the performance of an index like the S&P 500.
Variable annuities grow according to distributions you make into sub-accounts, which are like mutual funds. An annuity agent can help you find the right mix to accomplish your goals.
Be aware that you’ll need a lump sum to purchase an immediate annuity, while you can typically buy a deferred annuity with either a lump sum or periodic payments. Some annuities also have fees like surrender charges for early withdrawals and expense fees for managing your account.
Split Annuity Example
Let’s say you have $300,000 to devote to a split annuity strategy and are using two fixed annuity contracts. The insurance company will guarantee an interest rate of 4% on both contracts.
You allocate $95,000 into the immediate annuity and $205,000 into the deferred annuity. (A financial expert can help you figure out exactly how much to put in each annuity to grow your initial principal back, but we’ll keep it simple here.)
Considering an initial premium of $95,000 and an interest rate of 4%, the immediate annuity would pay you about $959 per month for 10 years with a total payout of $115,032.
During that same time, your other $205,000 is growing in the deferred annuity at a rate of 4%. Your account would be worth $303,450 at the end of the accumulation period, which is more than what you started with when you bought the SPIA.
You can then receive fixed payments from the deferred annuity according to your contract.
Why Choose a Split-Funded Annuity?
The main benefit of a split-funded annuity is that you can have guaranteed income now and grow an account for income later.
An immediate annuity starts paying right away but doesn’t let you build value via an extended accumulation phase.
A deferred annuity lets you build tax-advantaged value but pays out later on. You get all the advantages of annuities with a split-funded annuity.
Is There a Downside to Split Annuities?
The downside to a split annuity is that one portion of your savings has more time to grow than the other. While you may regain the immediate annuity’s value through the deferred account over time, your funds would grow more overall if you purchased a single deferred annuity from the start.
So, if you had contributed all $300,000 into a deferred annuity instead of splitting your contributions, the account would grow to $444,073 based on a 4% interest rate and a 10-year term.
How To Decide if a Split Annuity Strategy Is Right for You
A split annuity can be a great tool for people who have recently retired or are approaching retirement. However, this all depends on your retirement plan, financial needs, and the amount of money you can put into each annuity type.
Dividing a larger sum can help you get meaningful income payments from an immediate annuity and grow a deferred annuity at the same time.
On the other hand, separate annuities may not provide enough retirement income if you split up a smaller premium. In some situations, you could get higher income payments from one annuity type than by using a split annuity strategy.
If you aren’t worried about having an income from an annuity right away, you can simply get a deferred annuity. That way, more of your money can have time to grow before taking payments from the annuity.
How To Divide Your Funds
The standard strategy for dividing funds in a split annuity is to allocate enough to the deferred annuity to recoup what you spend on the immediate annuity.
Calculating this ratio involves knowing the interest rates, time periods, and fees of both annuities. An annuity expert can help you calculate the right way to divide your funds toward this goal.
Keep in mind that this strategy requires enough time for the deferred annuity to grow a substantial amount. In our example above, 10 years provides enough time for $205,000 to grow back to $300,000 with a 4% interest rate.
If you want a five-year split annuity, you’ll have to put more in the deferred annuity and less in the immediate annuity. You can allocate $250,000 to the deferred annuity to grow about $50,000 to cover an immediate annuity of the same cost.
Advanced Annuity Strategies
Purchasing and annuitizing multiple annuities over time can help you maximize your return. One option involves starting another split annuity strategy right after the payments from the first immediate annuity run out.
At this time, you’ll have your total initial payment back thanks to the growth of your deferred annuity, and you can simply restart the process.
Another strategy used by annuity owners is called an annuity ladder. This involves taking out multiple immediate annuities over time. The main reason is to take advantage of rising interest rates in the market.
Say you have $100,000 to invest in annuities. You can start an annuity today for $50,000 then wait a few years to see if rates increase. If they do, you can start another annuity at that time for the remainder of your investment. Payout periods may differ and overlap in this strategy.
Get Expert Split Annuity Advice
A split annuity strategy can provide income security now and later in retirement, but there are a lot of factors to consider before you make a purchase. For example, can you contribute enough money to each account to earn two streams of income?
You also have to decide which type of annuity is best for each portion of the split. Perhaps you want the security of a fixed annuity over the growth potential of a fixed-indexed or variable annuity.
While these choices might seem daunting, you don’t have to make them alone. An annuity expert can look at your unique situation to help you chart your path forward. Speak with one of our licensed annuity agents to decide if a split annuity is right for you.
