Annuitization Definition and Annuitizing an Annuity

Among all financial vehicles, there is only one product that can guarantee steady income for life. That product is an annuity, also known as an immediate annuity.

This type of annuity contract allows you to convert assets (like savings accounts, CDs, IRAs, 401(k)s, and deferred annuities) into a stream of income payments.

This conversion is known as annuitization.

When you annuitize, you’re essentially cashing out your annuity by converting it into periodic payments.

You can annuitize all of your annuity or just a portion of it. You also get to choose the timing and frequency of these periodic annuity payments. One of the payout options is to receive guaranteed lifetime income—that is, income for the rest of your life. It is important to note that the decision to annuitize your money is irrevocable.

Once you move your money into an immediate annuity and annuitize, it is there to stay.

Let's take a deeper look into the concept of annuitization.

What Does It Mean to "Annuitize" Your Money?

There are two types of annuities to consider when discussing annuitization: deferred annuities and immediate annuities.

Deferred annuities grow in the same way that other retirement accounts grow: by earning interest based on your crediting rate. While the money grows, this is known as the accumulation phase.

Once you decide you are ready to receive the income, you annuitize the proceeds by converting your annuity into a stream of periodic payments (annuitization). This starts the guaranteed cash flow, and you begin receiving money in the form of payouts (typically monthly payments).

This second phase is known as the annuitization phase. With immediate annuities, there is no accumulation phase. You pay your premium to the insurer, and almost immediately, the account is annuitized.

This means, very soon after you purchase an immediate annuity, you begin receiving periodic income payments.

So, annuitization simply means that you convert your annuity product from a deferred annuity to an immediate annuity. Or that you purchase an immediate annuity using funds from other financial accounts.

Once you annuitize, this starts the flow of money from the life insurance company, and you begin to receive your periodic income payments. It is important to note that annuities are the only product on the market that can guarantee income in retirement.

Once your account is annuitized, you have a few options for how to receive the money.

You can either choose to receive the payments for a specific amount of time or for the life of the annuitant. The annuitant is the person who collects the payouts. Often, the annuity holder and the annuitant are the same person. The holder (or the owner) is who funds the annuity and signs the annuity contract. The holder names the annuitant in the contract, and the life insurance company uses the annuitant’s life expectancy to create the payout schedule and payout amounts.

In most annuities, payouts can go to only one annuitant. However, with a joint-life annuity, you can name two annuitants. We will look at the most popular annuitization options in a second.

The Core Benefits of an Immediate Annuity

The number one core benefit of an immediate annuity is financial peace of mind.

Annuitizing an annuity means consistent income payments. It means financial security that could last the rest of your life.

Only immediate annuities can guarantee that stability. Many retirees worry about the possibility of running out of money. With historically low rates of return on investment products like savings accounts and CDs, retirees may wonder if their social security benefits will be enough to cover their financial needs.

And for those who are lucky enough to retire with pension benefits or other retirement funds, most do not enjoy the security of monthly income from these accounts, like they would with an immediate annuity. Research from LIMRA's Secure Retirement Institute proves that guaranteed income has a positive psychological impact on retirees.

Those who reap the benefits of an annuity feel more confident. By using a portion of their retirement savings to purchase an annuity, they’re able to fund their preferred retirement lifestyle.

The bottom line?

Annuitizing a portion of your nest egg hedges against the risk of outliving your money, creating lasting peace of mind.

Types of Annuitization Payouts

As the annuity owner, you decide how to structure the payments the annuitant will receive during annuitization.

The insurance company usually presents a handful of options depending on the type of annuity you choose.

The most common options are listed below.

Lifetime Payments

The most straightforward option for annuitization is called a straight lifetime payment. With this option, the insurance company makes payments to the annuitant for the annuitant's lifetime. Obviously, this can be for a matter of months or decades.

The longer the annuitant lives with the lifetime payments option, the better value the annuity provides. Keep in mind that if the annuitant dies soon after annuitizing, the insurance company does not provide a refund. However, the annuity owner may purchase death benefits and name a beneficiary to inherit the annuity.

Life With Period Certain

With straight lifetime payments, the annuitant risks losing the annuity money if they die earlier than expected.

To avoid this risk, the owner can add a period certain feature to the straight life option. With this feature, the annuitant receives payments either for their entire life or for a certain period that the owner chooses—whichever is longer. For example, suppose the owner chooses a 20-year period certain option.

The payments last for at least 20 years, whether or not the annuitant dies during this period. But if the annuitant lives for more than 20 years, payments continue for as long as they are alive.

With this type of guarantee (20 years certain), the payments are smaller than those with a straight lifetime payment.

Joint and Last Survivor

Some annuity buyers may want to provide income for themselves and for someone else, like a spouse or sibling.

A joint and last survivor annuity option provides income as long as either of the people identified in the contract remains alive. The joint and last survivor option provides smaller payouts, like the life with period certain option.

This is because of the guarantee that payments will continue for the longer of the two participants' lives.

Period Certain

The final most common option is the period certain payout. Period certain provides guaranteed retirement income for a specific time without the possibility of receiving lifetime payments.

Essentially, period certain instructs the insurance company to pay the annuitant for a specific number of years. The longer the annuitant receives payments, the smaller the monthly amount will be and vice versa.

Other Options

Your insurer may provide you with other payment options. Just make sure you get a complete rundown of all of your options, so you are completely informed.

The Magic of Annuitization

Many financial advisors and licensed insurance agents suggest that retirees with limited income sources apportion part of their retirement nest egg to an annuity.

That way, they are guaranteed money that they can use to pay bills and other monthly expenses.

Regardless of what payout option you choose, the main goal of annuitization is to offset the risk of outliving your assets. There is only one financial product that can help you meet this goal: an annuity.

Take the time to ask lots of questions before purchasing your annuity. If the insurance agent doesn't sufficiently answer your questions, seek out a financial advisor before signing on the dotted line.

If you’re a 401(k) or IRA owner and want to purchase an annuity, Canvas Annuity has great options.

If you’re still figuring out your financial plan, get in touch with the non-commissioned agents at Canvas!

They can help you learn more about what an annuity can do for your retirement plan, and how it can help you secure your financial future.

You can even use the self-serve feature and buy directly online. Start today!

Citations

LIMRA Secure Retirement Institute (2018) -- More than Half of Consumers Would Choose Guaranteed Lifetime Income over a Lump Sum Payment

The Balance (Pritchard, 2020) -- What does it mean to annuitize?

Kiplinger's (Nuss, 2020) -- Remove Financial Worries from Retirement with a Do-It-Yourself Pension