Annuitization Basics: Understanding Your Annuity

Let’s say you want to turn your savings into an income stream to enjoy a stable retirement. An annuity allows you to do this – but you have a lot of different options to choose from. Plus, seemingly small differences in terms may have a big impact on how much you receive. Make sure you receive the best deal by learning some annuitization basics.

Securing a Paycheck for Life

If you’ve ever dreamed of winning the lottery, you may be familiar with the idea of an annuity in a different context. Lottery winners can typically choose to collect their winnings a single lump sum payment or as an annuity paid out over a period of years. While the lump sum may be tempting, the annuity option ultimately provides a much larger payout. It also makes it easier for winners to manage their new riches, helping them to avoid large tax burdens or blowing the money all at once.

Annuities for retirement offer similar advantages. When you buy an annuity, the total payments you receive can exceed your initial investment because you’ll also receive a crediting rate that allows your annuity to grow, although this will depend on a number of factors, including the type of annuity, the crediting rate, your longevity, and whether you take funds our or surrender the annuity early. Annuities are also helpful for retirees who are worried about running out of money, as the regular payments help you stick to a budget. Some annuities will provide guaranteed income for life.

How Annuitization Works

Annuities gain their name from the process of annuitization. However, annuities actually go through two phases:

• The accumulation phase is when the annuity grows. During the accumulation phase, the annuity holder makes one or more premium payments to fund the annuity. The annuity also grows according to the stated crediting rate in the annuity contract.
• Annuitization refers to the process of converting an annuity into a stream of periodic payments. During the annuitization phase, the annuity holder receives payments, often on a monthly basis. The annuity holder does not make premium payments during this period.

Annuitization in Different Types of Annuities

While the above explanation covers the basic idea, the specific details of accumulation and annuitization will vary depending on the type of annuity you have and the terms of your annuity contract.

For example, some annuities are funded through a series of payments over years, and they may not begin paying out until a later date, resulting in a long accumulation phase. Other annuities are funded with a single payment and benefits may begin nearly immediately, with little

or no accumulation phase. Likewise, the annuitization period varies: some annuities offer payments for a fixed period (such as 10 or 20 years), while other annuities offer lifetime income.

To simplify things, let’s look at how the accumulation and annuitization processes differ in two attractive annuity options for retirees: a multi-year guaranteed annuity (MYGA) and a single premium immediate annuity (SPIA).

• MYGA’s crediting rates are fixed for a period of time you select, meaning your annuity grows at the stated guaranteed crediting rate during the term and is protected against market volatility. These annuities provide dependable growth for a predetermined period of time, which is usually between two and 10 years. However, when this term ends, your contract continues to earn the crediting rate that is declared by the insurance company at that time.
• SPIAs are funded with a single premium payment and the payouts begin almost immediately. As the annuitization process is not deferred, this may be a good option for retirees who want an income source that starts immediately. Although there are different SPIA options with varying structures, a common option provides a 10-year period with life contingency, meaning it guarantees payments for at least 10 years (either to the annuity owner or a beneficiary) and then continues for the rest of the annuitant’s life.

Death Benefits After Annuitization

Although many retirees like the idea of a steady income stream, some are worried about what will happen if they die soon after purchasing an annuity. Will they lose all their money? Will their loved ones miss out on the chance to inherit that wealth? The answer depends on the details of your annuity contract and what it says about death benefits. When you consider your annuity options, find out if the annuity provides “period certain” terms or joint and survivor benefits.

• Death benefits. Some types of annuities provide death benefits – or money that will go to your beneficiaries if you pass away. However, whether death benefits are available depends on the details of the contract. It may come down to whether the annuity owner started to receive annuity payments before passing away. If the annuity owner dies after annuitization has occurred and payouts have begun, there may be no death benefit – but this is completely dependent on the terms of the annuity contract, as not all annuities work the same. With some annuity companies, you can add a death benefit rider when purchasing the annuity, but there may be an added cost for this feature.
• Period certain. While some annuities only offer lifetime payments that end when the annuity owner passes away (leaving nothing for the owners’ beneficiaries), other annuities have a “period certain,” during which annuity payments are guaranteed. If the annuity owner dies during this period, the beneficiaries receive the funds, most likely in the form of continued payments to the new payee until the end of the period.
• Joint and survivor. Some annuities are single life annuities, meaning they are written for a single annuitant. Other annuities offer joint and survivor benefits, meaning they are written for two annuitants and continue to pay benefits to the surviving annuitant after the other annuitant passes away. For example, a married couple can purchase an annuity with joint and survivor benefits. If one spouse passes away, the other spouse will continue to receive payments. You can typically select the percentage of benefits you would like the survivor to receive, such as 50%, 75% or 100% of the original payment. By selecting a higher amount to go to the survivor, you will receive somewhat lower payments to start.

If you are worried about your loved ones missing out on funds, it’s important to consider these details when comparing your annuity options. There are many annuity options that will provide something for your heirs, but not all do.

For example, if you are buying an SPIA, you may have the following payment options:

• Cash or Installment Refund. The annuity will pay out AT LEAST the amount of the original premium payment, no matter when the annuitant passes away. If you select cash refund, any amount remaining at death will be paid in a lump sum to your beneficiaries. If you select installment refund, the amount remaining will continue to be paid in the way it is currently being paid, but the payee will switch to the beneficiary.
• Life Contingent. Payments last as long as the annuitant is alive but there is no cash to the beneficiary. The upside is that this typically allows for the largest monthly payout to the annuitant.
• Annual Increase. The owner can select an amount that they would like annuity payments to increase by each year. Many people select a 3% increase since that is traditionally an amount that can keep pace with inflation.

Do You Have More Questions About Annuitization?

When it comes to annuities, the fine print matters. Although topics like annuitization can be confusing, it’s important to understand the annuitization basics and how your annuity contract language affects the benefits that you and your beneficiaries receive. Canvas is here to help you understand your options. Check out our Frequently Asked Questions, or contact us for more information.