Annuity Payout Options: What You Need to Know
“If you are preparing to purchase an annuity, you will need to decide when you want your stream of periodic payments to begin. The time when the income stream turns on is known as the “annuitization” phase. “- John Ripley
There are several ways to receive payments during the annuitization phase of an annuity contract. There are also numerous ways to use an annuity for both growth and income without using the annuitization feature.
While there is no single right option for receiving annuity payouts, you should always base your choice on your current financial needs, retirement goals, and input from your annuity expert.
With annuities, you have choices. Next to their ability to provide guaranteed income streams and protect against market risk, the best thing about annuities is that they give you options, especially for principal protection and future income payouts.
If you want to convert a lump sum of cash into an income stream, you can use right away; an immediate annuity might be a great choice.
Immediate annuities don’t have what’s known as an “accumulation period.” Instead, they are funded with a single lump-sum payment rather than with a series of premium payments as are deferred annuities. The distribution period for immediate annuities usually begins within 12 months after the date of purchase.
A typical use of an immediate annuity is to provide benefits from a terminated pension plan. Structure settlements of lawsuits also often take the form of an immediate annuity.
When you purchase a deferred annuity, you will make either a lump-sum payment or series of premium payments, deferring payouts until a specified time in the future. This period when you are paying into an annuity is called the accumulation period. The use of a Fixed Indexed Annuity, in this case, could be a wise choice as you can benefit from favorable trends in global markets via a link to an “index” or even multiple indices during the accumulation period.
Earnings in your deferred annuity aren’t subject to taxation until distribution, and you can benefit from the additional potential growth of principal by deferring taxes to a later date. However, the idea that you will be in a lower tax bracket in the future when you retire is suspect for most Americans. You must use great care to account for future taxable income, including the Required Minimum Distributions associated with tax-deferred accounts, to ensure that your overall strategy is tax-efficient and fiscally sound. You also must remember that if you take money out of your annuity before you reach age 59 ½, you will, in most cases, be subject to a 10% penalty plus owe the taxes on the withdrawn amount.
Deferred annuities are often chosen by people who want to grow their money tax-deferred to supplement their future retirement income.
Remember that with all annuities, any guarantees are subject to the claims-paying ability of the issuing company. It’s a good idea to spend time researching the issuing company thoroughly before buying any financial product. The insurance industry remains one of the most robust and reliable financial sectors the world over. Still, some companies are more reliable than others, and the opportunity to select a great company with multi-featured annuities has never been better.
For how long do you want payments? Once you’ve decided whether you want an immediate annuity or a deferred annuity, you must consider how long you wish to get money from the annuity company.
Annuities, as you know, can either provide contractually guaranteed lifetime income or they can provide payments for a certain period. They can also offer a systematic return of your principal without using the annuitization feature. Concerning Fixed Indexed Annuities, many of these annuities offer Lifetime Income Benefit Riders, which provide the attractive aspects of lifetime income without the irrevocable decision of annuitization.
Some annuities will also ensure that your spouse has income after you die. Like the Survivor Benefit Program for federal or military pensions, annuities can offer spousal benefits even after the annuity owner passes away.
Two of the most popular options for annuity payouts are period certain and life.
Life annuities, which are sometimes called single life, life only, or straight life, pay you a predictable income for the rest of your life. Choosing this option helps you safeguard against the genuine risk of outliving your money. The amount invested and your life expectancy are the metrics used to determine your lifetime payout. Life annuities do not provide guaranteed money for your spouse or heirs after you pass away.
A period certain annuity is a little like term life insurance, which only provides coverage for a set number of years. A “period certain” annuity guarantees payouts for a specified time and, therefore, does not offer a hedge against longevity risk, i.e., outliving the money. While period certain and life are the two most widely-known annuity payment options, there are other payout methods available that may better suit your unique situation.
For example, an option growing in popularity is a hybrid payout option known as “life with period certain.” Life with period certain guarantees you a predictable and reliable stream of income for life. Still, it also ensures that your beneficiary will get the remaining annuity payments should you pass away during a specific period, usually 5, 10, or 15 years. If, for example, you purchased a life annuity with a 15-year period certain and died after five years, there would be ten years more of payments to your beneficiary. On the other hand, if you die after 16 years, your beneficiaries get nothing. This option is a bit like rolling the dice.
Other payout choices include:
Lump-sum distributions. There are significant tax issues involved with lump-sum distributions, including the IRS requirement that taxes must be paid in the same year as the payouts occurred. Some people need money unexpectedly, and the annuity provides that source of immediate cash. However, a well trained financial expert can help you evaluate all of your options in times like these to mitigate unnecessary tax payments by seeking to find available remedies amongst all of your assets.
Systematic withdrawals of fixed amounts. Selecting systematic withdrawals allows you to choose the dollar amount of payments and the number of payments you want to get. Systematic withdrawals, however, do not guarantee income for life. Payments last only as long as you have money in your annuity account. Suppose you have chosen a Fixed Indexed Annuity, and the global economy is strong during your retirement. In that case, you may be able to increase your systematic payments based on the growth of the principal of your annuity. If the economy is not favorable, your principal remains intact other than the withdrawals you make from the account.
When you elect to take money from an annuity before reaching age 59 ½, you will pay the taxes owed plus a 10% penalty. Also, in some cases, if you take out more than the allocated annual distribution, you may trigger a surrender charge or access fee. Again the use of a trusted advisor is critical in determining the suitability of any financial instrument. Surrender or “access fees” are indeed good things that allow insurance companies to offer annuities with more benefits to consumers than those accounts that do not have access fees or penalties. Accounts such as checking or money market account provide consumers 24/7 access to their funds. The tradeoff of having unlimited liquidity is a near-zero return.
If you understand that the purpose of money should dictate the placement of money, then using an annuity with an extended surrender period could be an ideal choice for the funds you do not need for several years. You wouldn’t put your grocery money in a five-year CD at your bank, so don’t put ALL the money you might need next year in a 10-year annuity. Conversely, you would not leave your grandchildren’s college fund in your checking account because a two-year-old won’t go to college for another 16 years. Funds needed in the future need to be in the “right place” based on their purpose, and an annuity in many cases meets the need perfectly.
Summing it up.
Buying an annuity contract is a decision you should undertake with a lot of care. You must decide the type of annuity that best fits your needs and goals. You will also need to choose a payout method that makes sense in your unique financial situation.
Annuities are complex insurance products that require thoughtful research before purchase, along with the guidance of a trusted expert.
A qualified retirement and income specialist will have the necessary tools and skills to help you make choices that align with your priorities.