Common annuity payment options to know
Annuities can be effective tools to generate a steady income stream in retirement - accumulating earnings on a tax-deferred basis until you're ready to make withdrawals. Unfortunately, many people don't fully understand the different options available during the payout (or annuitization). Here we provide some information to help you gain knowledge.
Annuity terms
Let’s start with a list of some terms that annuity buyers should know.
Insurer — The life insurance carrier that issues the contract and collects premium payments, then pays them out to the payee as specified in the contract.
Owner — The investor who purchases the contract and usually pays the premiums into it. (There can be joint owners, and the contract can also be owned by an entity.)
Annuitant — The person whose life expectancy is used to calculate the payout from the contract at annuitization. (There can be joint annuitants.)
Payee — The person who receives the annuity payments at annuitization. (There can be joint payees, and the owner, annuitant and payee are often the same person or persons.)
Annuity payout period — The period of time where the payee receives a payout from the contract at annuitization.
Phases of an annuity
Prior to evaluating your payout options, it’s important to understand the phases of an annuity.
The accumulation phase is the period in which you contribute money to the annuity either through a series of payments or a lump sum. During this period, the annuity has an opportunity to grow in value.
The annuitization phase is when the life insurance company distributes payments from the annuity. The income from an annuity can be paid out in a lump sum or through a series of payments. These payments can provide a stream of income for retirement.
What is an annuity payment?
An annuity payment is a regular payment you receive after you've converted your annuity's contract value into a stream of income payments through a process called "annuitization.” The payments can be monthly, quarterly, or yearly, depending on the term of the annuity. Payments are received typically during retirement and can be used to help cover living expenses.
How does an annuity payout?
An annuity pays out by distributing the money you’ve invested along with any earnings, either as a series of regular payments or as a lump sum.
Common annuity payout options
Now that you understand a little about how an annuity works, we’ve listed some of the most common payout options.
Life-only
Life-only provides you with regular, guaranteed income payments from your annuity for life. By choosing this option, you essentially eliminate the risk that this income source will run out before you die. The payment amount of a life-only annuity option is determined by your contract value at the point of annuitization, age, gender, interest rate, life expectancy and potentially other features of the product.
Joint and survivor
Joint and survivor life ensures the retirement income provided by your annuity will continue for your spouse when you die. However, payments are calculated and based on the life expectancy of both you and your spouse, making payments for the joint-life option lower than with the life-only option.
Fixed period
Fixed period (or period certain) is an option that allows you to select a specific time period for which your annuity payments will last. Because you won't be receiving payments for life (as with the life option), payments are higher, but you run the risk that your annuity payments will run out before you die. If you die before the specified period ends, the remaining payments will continue to be made to your designated beneficiary for the rest of the fixed period. For example, if you're age 65 and select 15-year period certain payout, your annuity contract will guarantee payments until you reach age 80.
Life with period certain
Life with period certain (or guaranteed term) provides you with guaranteed income for life (just like the life option), but also allows you to select a specific time period for which your annuity must pay your beneficiary should you die before that guaranteed period ends. While this option provides you with income for life, payments are generally smaller than they would be under the life-only payout.
Fixed amount
Fixed amount (or systematic withdrawal schedule) allows you to select the amount of the payment you want to receive each month. The payments continue until the total accumulated value has been paid out. The duration of payments will depend both on the amount chosen and the annuity's accumulated value at the time of annuitization. For this reason, the insurance company cannot guarantee that you will not outlive your income payments. If you die before the full amount you’ve invested has been paid out, the remaining balance is typically paid to your designated beneficiary.
Lump-sum payment
Lump-sum payment allows you to receive your annuity payout in one lump sum. However, in the year you take the lump sum you'll have to pay income taxes on the entire investment-gain portion of your annuity. For some qualified accounts the entire sum may be taxable. Be sure to consult a qualified tax professional or financial advisor before taking a lump sum from an annuity.
Selecting the payout in your annuity
Selecting the best annuitization payout for your annuity can be confusing. Here are some considerations to take into account as you decide which payout option may be right for you.
How much – Begin by deciding on the amount of money you will need each month to live on or to supplement your retirement.
How long – Consider how long you think you’ll need to receive payments. If you will be using payments for a significant portion of your income, you may consider a payout option that guarantees payments will be made until your death.
Legacy considerations – Consider the needs of any beneficiaries and compare payout options that include the potential for beneficiary payments.
Frequently asked questions
Are annuity payouts taxable?
Yes, an annuity payout can be taxable, but the taxation depends on how the annuity was funded and the type of payout you receive. Be sure to consult a qualified tax professional or financial advisor to understand the full tax implications.
Is an inherited annuity payout taxable?
Yes, an inherited annuity payout is taxable, but the extent and timing of the tax depend on how the annuity was structured and how the beneficiary chooses to receive the payout. Beneficiaries should consult a tax advisor or financial professional to understand the full tax implications to make the best decision based on their financial needs.
Do annuity payments count towards RMDs?
Yes, the annuity payments can count toward RMDs if the annuity is held within a qualified retirement account, such as an IRA or 401(k).
Annuities are intended as vehicles for long-term retirement planning, which is why withdrawals reduce an annuity’s remaining death benefit, contract value, cash surrender value and future earnings. Annuities also may be subject to income tax and, if taken prior to age 59 ½, an additional 10% IRS tax penalty may apply. Because Protective and its representatives do not offer investment, legal or tax advice, it is important that you talk with your own investment, legal and tax professionals about your specific tax situation.
Not all annuities provide these options, and some may offer different payouts. All guarantees are subject to the claims-paying ability of the issuing insurance company.
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