Annuity Payout Options: Selecting the Right One for You

Annuities are the only financial product that can guarantee income for life. Understanding your annuity payout options can help you create a retirement savings and income plan customized for you.

Annuity contracts can help you accumulate money on a tax-deferred basis by making a single payment or periodic annuity payments prior to retirement. This money is then distributed to you in retirement via a stream of monthly payments. When you are ready to create a post-retirement income plan, annuities — along with social security payments — can be a solid foundation of guaranteed income.

Annuity payout options generally are presented in two ways: when you start receiving payments (right away or later) and how the payments are structured.

Annuity Payouts Depend on When You Want to Receive Payments

If you are several years from retirement and are interested in accumulating money on a tax-deferred basis (tax-deferred means you aren't taxed on the gains in the contract until you begin receiving payouts), then you can buy a deferred annuity. The period of time where the annuity is growing is known as the accumulation phase. If you are in or near retirement and are interested in receiving payments right away or at a future date during your retirement, you could buy an immediate or deferred income annuity and enter the annuitization phase. Let's explore your annuity payout options based on when you start receiving payments.

Let's explore some scenarios:

You currently own a deferred annuity that has been accumulating gains. As the annuity holder, you can annuitize your annuity contract when you are ready to begin receiving payments. The process of annuitizing directs the insurance company to take your annuity assets and begin making payments to you from the money in your annuity. Contact the annuity company or your life insurance agent to begin the process and to choose your annuitization payout method (see below).

You don't currently own an annuity, but you want to buy one to provide guaranteed income soon. In this case, you would buy an immediate or deferred income annuity from an annuity provider. If you are funding the purchase from a savings account, CD, or similar account where you have already paid taxes on the money, then you are buying non-qualified annuities. If, however, you are using funds that have not yet been taxed (a 401k or IRA, for example), then you are buying a qualified annuity.

Once you have decided to create a stream of income and how you will fund it, you generally have two options (or a combination of the two).

Immediate Annuities: This is the option when you want to begin receiving income right away. An immediate annuity provides you with monthly income payments for a guaranteed period of time that you choose (more on that in a minute) in exchange for an initial lump-sum investment. They’re called “immediate” because you begin receiving the monthly benefit payments almost immediately after you deposit your money (usually within a year).

Deferred Income Annuities and Qualified Longevity Annuity Contracts (QLACS) There are types of income annuities that allow you to defer your annuity payments until a later date. Some people like this option (sometimes used in conjunction with a traditional immediate annuity) to begin receiving guaranteed income at older ages. These types of annuities can help cover expenses like medical and long-term care costs that are more prevalent at older ages.

Types of Annuity Payment Options

Once you determine when you want to receive your payments, it is time to decide how you want the stream of income paid out to you and your loved ones in what is called the payout period. There are several annuitization payout options available depending on your personal situation.

Some common payout options include:

• Single-life (straight life, life only)
• Life annuity with period certain
• Joint and survivor
• Lump-sum payments
• Systematic annuity withdrawals
• Early withdrawals

There may be additional annuity payout options offered by your annuity provider.

Single Life or Life Only

Single Life Annuities, (also known as life only annuities) provide the highest payout, but only for the life of you, the annuitant. When you die, the series of payments stop. These are best for unmarried people and those with a long life expectancy.

Life Annuity with Period Certain

You can choose to receive monthly payouts for life, but hedge your bet by adding a period of time that will guarantee monthly annuity payments no matter what. This income would be paid to you but can pass to a beneficiary when you die.

Let's say you had a lifetime annuity with a 20-year annuity period. The insurance company promises to pay out for the rest of your life, but no less than 20 years.

Joint and Survivor Annuity

The joint and survivor annuity (or joint life annuity) option pays money for the duration of two people's lives. If you pass away first, your spouse will continue receiving payments for the rest of their life as a survivor benefit. If they pass away first, you would keep receiving an income stream for life. Since two people will be eligible, there are reduced payments vs a single life option.

Lump-Sum Payment

When you take a lump sum, you receive the entire annuity payment upfront. This defeats the purpose of guaranteed payments, the hallmark of an annuity, and also comes with an Internal Revenue Service (IRS) tax burden in the year the money is distributed.

This option should only be used in an emergency or if your financial position allows.

Systematic Annuity Withdrawal

With this withdrawal choice, you create custom periodic payments over time vs. an annuitization. You are not limited to a set amount of money every month.

The disadvantage is that it does not guarantee a lifelong monthly annuity stream for the annuitant, placing the risk of a longer-than-expected lifespan on the shoulders of the annuitant. Once the value of your annuity reaches zero, you won’t receive any more payments. The benefit is you can still direct the amount and timing of the withdrawals.

Early Withdrawal

If you take money out of an annuity before the end of the surrender period, you may face a surrender charge from the insurance company and have an IRS tax burden in the year of withdrawal as well. Annuities are meant for retirement savings/income. If you take the money out before age 59.5, the IRS may also impose a tax penalty on the gains.

This option should also be used when you have a financial emergency and must have the money right away.

Death Benefits and Payouts if the Annuitant Dies

Death benefits from annuities can help you provide a benefit to heirs and leave a financial legacy for your beneficiaries.

These funds can, for instance, help fund a spouse's retirement or help children buy a home. Heirs can take an annuity death benefit as a lump sum payment or as regular periodic payouts.

With periodic payments, your beneficiaries can choose a single life (monthly payments for the life of a single person) or term-certain (payments guaranteed for a specific period of time) annuitization option. With the single life option, if there is still a balance after the beneficiary dies, the annuity is terminated and any value left remains with the insurance company.

If the beneficiary chooses not to annuitize the death benefit, they will be subject to what is called the five year rule of distribution. The five-year rule requires the beneficiary to withdraw the entire balance of the annuity within five years of the owner’s death.

The beneficiary has several options with the five year rule:

• Take all the money out after the death of the owner
• Take periodic payments at any time during the five-year period
• Take all the annuity proceeds at once during the fifth year

There are specific IRS rules regarding the taxation of death benefit proceeds and inheriting an annuity. In general, the recipient pays taxes on the entire amount of the distribution if the annuity was in a qualified annuity contract (taxes have not yet been paid on the principal or gains), but they only pay taxes on gains if the annuity was non-qualified (taxes were paid on the principal already.)

Which Payout Option is Best for You?

When you are close to retirement and are ready to begin receiving regular, guaranteed payments, you may want to meet with a financial professional. The choices, as indicated above, are numerous and can be complex. The good news is that one or more of the options are likely a good fit for your unique retirement income needs.

If you are many years from retirement, an annuity can be an excellent way to grow money on a tax-deferred basis. Canvas annuities are multi-year guaranteed (MYGA) fixed annuities, meaning that they are a conservative vehicle for growing money. Their rates for three and five year guarantee periods are among the best in the industry. Also, their "buy-direct" internet platform allows you to easily purchase our annuities in minutes. Check them out at www.canvasannuity.com

Sources:

Smart Asset -- What Is a Joint and Survivor Annuity? (Lake 2020)

Forbes -- What is an Immediate Annuity (Rodeck 2021)

Smart Asset -- What is a Single Life Annuity? (Henrichs 2022)

Smart Asset -- Annuity Payout Options: What is Period Certain? (Lake 2020)