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.
Let's start with a list of some terms that annuity buyers should know.
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.
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.
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.
Now that you understand a little about how an annuity works, we've listed some of the most common payout options.
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 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 (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 (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 (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 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 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.
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