Annuitization: Should You Annuitize an Annuity?
Annuities are becoming an increasingly popular retirement savings vehicle for people in the U.S. Many folks are seeking alternative instruments that can guarantee them a stream of income for life.
With corporate pensions gradually disappearing from the financial marketplace, annuities have emerged as a viable substitute for these bygone streams of income.
Most annuity contracts today come with a variety of benefits and features that were unheard of a generation ago. Living and death benefit riders, guaranteed income riders, and disability and long-term care riders are now commonly available in many annuity products.
However, in order to take advantage of many of these benefits, the annuitant will have to give the insurance company permission to annuitize their contract.
Annuitization is a one-time, irreversible event that ends the accumulation phase of the annuity, where money was being put into the contract or a lump sum of money was left to grow on its own. Annuitization marks the start of the payout phase of the annuity.
Annuitization and How It Works with Different Annuity Types
Immediate annuities annuitize at the time the contract is purchased by the annuitant. In other words, immediate annuities have no accumulation phase and start paying income right away.
On the other hand, variable and other fixed-type annuities tend to have a “ deferral period,” or where their income payments start at a later date.
At this later period, you can choose to either annuitize your variable or fixed annuity contract – or to have more flexibility by choosing from among a handful of other payout options.
The Annuitization Process
When you decide to annuitize your annuity contract, the life insurance carrier will convert all of the accumulation units (the units that were bought with each premium payment made into the contract) into annuity units, which are used to pay out the stream of income from the contract.
The three main factors that go into the life insurance company’s calculation of the payments are:
- The annuitant’s life expectancy (as determined by the actuarial tables),
- The amount of money in the contract, and
- The type of payout that is chosen by the annuitant.
The annuitant is simply the person whose life expectancy is used to calculate income payments for the purpose of annuitization. In many cases, the owner of the annuity is the annuitant, but they don’t have to be.
Other parties besides the annuity owner can also be designated as an annuitant.
What Payout Options Do You Have with Annuitization?
The possible payout options include:
Straight Life
This choice is also known as a life-only payout. It will pay the annuitant a stream of income for as long as they live. The risk to the annuitant is that if they die before receiving back at least the amount that was originally put into the contract, then the insurance company gets to keep the remaining balance.
However, there is good news if the annuitant outlives their life expectancy and completely exhausts all of the principal and growth in the contract. Then they will continue to receive guaranteed payments until they pass away.
Joint Life
This is similar to straight life, except that the monthly payment is made to a married couple. Payments will stop upon the death of the first spouse. The same risks and benefits apply to a joint payout as for a straight life payout.
Joint Life with Right of Survivor
This type of payout will continue as long as either of the spouses lives. Payments will cease upon the death of the second spouse.
The payments are generally expected to continue for a longer period of time than with a joint life payout. Because of that, payments for this option will be lower than for a joint life payout.
Period Certain
This is perhaps the most straightforward option of all of the income options the annuitant can choose.
With this option, the annuitant simply names a specified period of time over which they want to receive payments. The principal and growth in the annuity contract will be exhausted by the end of the term.
This option can also be included with any of the first three payout options as an added measure of security.
For example, a joint life with a period certain of 20 years guarantees that the couple will receive lifetime benefits. Any excess benefits would be paid out to a contingent beneficiary if neither of the spouses live for another 20 years.
So if the second spouse dies after getting 13 years of payments, then the contingent beneficiary would get the remaining 7 years of payments. Of course, this guarantee means that the initial payments will be slightly lower than they would be without the period certain added.
Annuitization – an Option in All Annuity Contracts
All insurance companies are required to offer annuitization as one of the payout options for their policyholders. But the option to annuitize can create a real dilemma for annuitants who want to get the most bang for their buck from their contract.
If they believe that they will outlive their life expectancy, then a straight life payout may be an option to consider (assuming they don’t mind the risk of any remaining balance going to the insurer).
If they are not sure whether they will live that long or not, then a life payout with a period certain could be a better choice.
Disability and Long-Term Care
It should be noted that some benefits offered by an annuity can only be had if the annuitant elects to annuitize the contract.
For example, many annuities that provide additional benefits for disability or long-term care require that the annuitant make an irrevocable payout choice before they can be activated.
Then, if the annuitant becomes disabled or unable to perform at least two out of the six activities of daily living (ADLs), the guaranteed payout will double or triple for a specified period of time. That period may last for two years, for example.
Afterward, the payment will revert to its previous amount for the remainder of the annuitant’s life. Triggering this type of benefit can often fully deplete the amount of the contract.
This is why insurers require the election to receive a guaranteed, irrevocable payout that will last as long as the annuitant does.
However, not all annuity contracts do this. Some contracts will assume that you are receiving guaranteed payouts from an income rider, and the calculations for this benefit will be based on that setup.
Ask your financial professional to review the specifics of what your annuity contract may have so you understand this well.
Lifetime Income Riders
One of the latest innovations in the life insurance industry is the advent of lifetime income riders. These riders can provide a guaranteed stream of income without the need to annuitize the contract.
The payments will be lower than what the annuitant would receive if they annuitized the contract. But the annuitant can also access the principal and growth in the contract. So, in that sense, people have more flexibility and money access by using this rider instead of annuitizing their contract.
Of course, any withdrawals from the principal will lower the future payments offered by the rider. But this flexibility appeals to many policyholders who were having difficulty deciding how to best draw out their money.
How Do You Determine if Annuitization Makes Sense?
You might want to consider going through the pros and cons of annuitization with your financial professional.
They will understand the advantages as well as disadvantages of different payout options. Chances are they have been been through many different client situations with this. You can put their knowledge to work for you.
You should know that fewer than 5% of all annuity contracts are annuitized. This is probably because many people prefer to still have some access to their money, among other reasons.
That being said, these factors below may also help you weigh your options and steer the conversation on what makes the most sense for your retirement income needs. Here are a few things to think over.
Questions to Ask About Annuitization
What are your financial objectives? Do you need guaranteed income for life? Or is still having some access to your money in the contract more important?
What does the rest of your portfolio and savings look like? If your portfolio has enough money in order to keep some dollars liquid, then annuitization may make sense for some of your retirement assets.
How will you handle the tax treatment of your annuity contract? Annuities grow tax-deferred, which makes the untaxed dollars become taxable as income when they are withdrawn.
If you withdraw your money all at once, there will be a larger tax payment due. Annuitization will give you a ‘set schedule’ for receiving payments that can’t be reversed or stopped, meaning your tax liability will be spread out over time.
However, receiving guaranteed income from an annuity with an income rider can also give you this same benefit.
Finally, don’t leave out flexibility. Is having flexibility important to you? Annuitization eliminates flexibility.
Should You Annuitize Your Annuity?
The decision on whether to annuitize your contract involves many variables. Be sure to consider all of your other assets when you make this choice.
If you have other liquid funds elsewhere, then annuitization may be a good idea for this portion of your money. If the bulk of your retirement savings is tied up in an annuity, then an income rider can provide income while still allowing you access to your savings if you need it.
Consult your financial advisor for more information on annuitization and whether it is right for you.
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