Are you looking for information on annuities and would like to learn more about how you can use them to your advantage? Annuities are effective tools for generating a steady stream of income even when you’re retired. It accumulates earnings through a tax-deferred method until the time you make a withdrawal.
However, most people won’t fully understand the various options available to them during annuitization. Below we discuss everything you need to know to build your knowledge and to help you make an informed decision on which payout option to choose.
What are Annuities?
Annuity refers to insurance contracts distributed and issued by financial institutions that have the intention of paying out funds in the future by means of a fixed income stream. Investors may purchase or invest in annuities through lump-sum payments or monthly premiums, where the holding institution will issue a stream of payments for a specified period of time, or during the remainder of an annuitant’s life. An annuity is more commonly used for retirement, or to help individuals tackle risks associated with outliving their savings.
Why Should You Buy Annuities?
Many people will typically purchase annuities as a retirement tool to help manage their income even when they no longer work. There are three main points as to why annuities provide an advantage, which are:
- You get paid over a specific amount of time, which may last for the remainder of your life. It can also apply to your spouse or another person of your choice.
- If you pass away before you’re able to receive payments, whoever you name as your beneficiary will be able to receive death benefits, in the form of a specific payment.
- You won’t have to pay taxes on the investment and income gains from your annuity, so you can enjoy tax-deferred growth until the time you withdraw your money.
When Do Your Annuity Payments Start?
Once you purchase an annuity, you will need to think about when you want your payments from the insurance company to start. Much like many of the different aspects of an annuity contract, there are a few options available to you. Ask yourself if you would like your payouts to begin right away — if you answered yes, then you might want to look into an immediate annuity.
But if you’re looking to grow your payments over time before you retire, it will be best for you to choose a deferred annuity to better suit your needs. Below is a table that better explains the difference between immediate and deferred annuities.
Immediate vs. Deferred Annuities
|Annuity Payout Type||Payments Begin||Potential Buyers|
|Immediate||Starts 30 days or 1 year after issue||Best for individuals who want to retire soon and want to use it as supplement income.|
|Deferred||A specified time in the future, such as your retirement||Best for individuals who want to grow their money through a tax-deferred basis to be used in retirement.|
Annuity Payout Options
There are also various methods by which you can receive payouts from your annuity, where the most common methods are the following:
- The annuitization method
- The lump-sum payment
- The systematic withdrawal
- Guaranteed Lifetime payout
Choosing an annuitization method will provide you with a guaranteed monthly income throughout a specific period of time, or for the rest of your life. Under a systematic withdrawal schedule, you can get complete control in terms of the timing of distributions you get but won’t give you protection against outliving your annuity assets. Below are detailed explanations for all of the available payout options.
Life Annuitization Option
This option generally gives the highest payout, where the monthly payment will only be calculated for the life of the annuitant. A life annuitization plan will help to provide your income stream for life, where you can get some protection from outliving your retirement income.
Life with Period Certain
This is a hybrid option for your annuity payout, which guarantees payments for the rest of your life. It also ensures that your beneficiary will receive the rest of your annuity payments should you pass away unexpectedly.
For example, if you had a life annuity with a 10-year plan but passed away after three years, there will still be seven years’ worth of payments for your beneficiary. But if you were to pass away after 11 years, your beneficiary won’t be able to get any money from your annuities.
Joint-Life Annuitization Option
This is a common option that will allow you to bequeath your income to your spouse should you pass away. While the monthly payments are lower compared to the life option, this is because the calculation will be based on the life expectancy of you and your spouse. It is also referred to as survivor annuities, so it is a popular choice for married couples.
When you choose this option, you can select the amount of payment you want to receive every month, as well as how many payments you want to get overall. However, you will need to consider that the insurance company won’t be able to guarantee that your income will last for as long as you’re alive. The amount that you receive as well as the number of months that you get payments will depend on how much money is accumulated in your account.
As a result, you will need to handle the burden of life expectancy on your own.
If you don’t want to spread out your payments over time, you may choose to get a one-time payout in full from your annuity provider. While this option might sound appealing at first, there are huge consequences when it comes to tax.
However, this option isn’t usually recommended, since it involves taking out all the assets inside your annuity. In the year that you take out the lump sum, your regular income taxes will be taken out of the investment-gain portion from your annuity.
When tax season arrives, you’ll likely be shocked to see that you’ve paid tax for the entire lump sum payment you took. As a result, this is quite an inefficient option to payout if you wish to minimize your taxes.
Period Certain vs. Guaranteed Lifetime Payments
After you choose between getting an immediate or deferred annuity, you will next need to consider how long you will need to get payouts from your insurer. An annuity can provide you with income that’s guaranteed for the rest of your life or for a specific period of time. When you pass away, your annuity provider may offer payments to your beneficiary, where there are two options for you to choose from.
Guaranteed lifetime or period certain payments are both great options when you want to receive payments without any worries. However, you will need to choose which option is best for you and your needs.
If you’re looking to get income for the rest of your life without the fear of outliving your retirement income, a guaranteed life payment is the best choice. But if you want a stable income for a set period of years, while allowing your beneficiary to receive your payments if you pass away, then a certain plan will work best for you.
Annuities or Life Insurance?
Investment companies and life insurance companies are the two main kinds of financial institutions providing plans for the annuity. When it comes to insurance companies, an annuity serves as a natural barrier for their insurance products. Life insurance is needed to deal with unexpected death, where policyholders will need to pay an annual premium that will pay out a lump sum amount.
Should the policyholder die prematurely, the insurer will need to pay out the death benefit at a loss to their company. On the other hand, annuities are designed to deal with risks in the long term or outliving your assets. To contain the risk of annuity holders outliving their initial investments, annuity issuers sell annuities to individuals with a higher risk for premature death.
Choosing the Right Payout on Your Annuity
Choosing the right annuity is a big decision for you to make so be sure to think about your priorities. You also need to think about the amount of money you need every month during your retirement as well as how long you need your payments to last. Another factor you need to determine is whether or not it’s important for your beneficiary to receive payments from your annuity should you pass away prematurely.
Always remember that annuities are a complex kind of insurance product, so it’s best that you speak with a professional financial advisor to help you make this decision. Speaking to an experienced advisor will also provide you with guidance regarding the benefits and costs when looking for an annuity.
It’s not easy to decide on the best annuity method, but be sure to consider your needs and your priorities. It’s also best to think about your plans for the future, and whether your spouse will need help should you pass away unexpectedly.
However, if you feel that you don’t need to take any amount at all, you may keep building up the funds that have accumulated in your annuity. Just be sure to check that you have the correct beneficiary designated to your annuity so that they can receive payment should you pass away. Have questions? Let us connect you with an annuity pro for a free consultation!