What is a Split Annuity? (Split-Funded Annuity Definition)

Financial planning for retirement can feel overwhelming, but it's important to get it right.

A good retirement plan can be the difference between worrying about what you'll order at the club restaurant and worrying about how you'll afford your next phone bill.

If you’re thinking about retirement, you should be thinking about annuities. An annuity is the only retirement planning instrument that can provide you with life-long guaranteed income payments once you stop working.

Of course, there are immediate annuities and deferred annuities, but what if you want a little bit of both worlds?

In those instances, you'd want a split annuity. In this article, we explain what a split-funded annuity is, how it works, and its advantages and disadvantages. By the end of this article, you'll be able to decide if it's the right funding strategy for you.

Immediate Annuities and Deferred Annuities

To understand split annuities, we first have to look at immediate and deferred annuities. There are many different types of annuities, each with different characteristics.

One choice to make is about when it starts to pay you back.

With an immediate annuity, you purchase the annuity and almost immediately, you begin receiving periodic income.

You fund an immediate annuity contract with a single premium (or lump sum). You might want an immediate annuity if you're in (or close to) retirement and need an immediate income stream.

In a deferred annuity, you purchase the annuity, and the money grows over a certain period of time.

When the period is up, the annuity pays out, providing you with your original principal plus earnings. You can fund your deferred annuity with a lump sum or through periodic payments. A deferred annuity could be ideal if you're planning ahead for retirement.

What Is a Split Annuity?

Let’s get one thing straight: A split annuity is not a type of annuity itself. A split annuity is actually a strategy for funding your annuities. In a split annuity strategy, you split up your investment so that instead of purchasing one annuity, you purchase two—an immediate annuity and a deferred annuity.

A split annuity strategy allows you to achieve two goals. It gives you a guaranteed income stream right now, and it grows your money for the future.

How Does a Split-Funded Annuity Work?

To get a split-funded annuity, you purchase your annuities: one immediate and one deferred. The immediate annuity starts paying you back soon after you purchase it—usually within the year. That starts your immediate income stream. The deferred annuity accumulates and grows tax-deferred over time.

By the time you need it, it will have grown substantially and pay you back much more than it would have as an immediate annuity. When purchasing a deferred annuity, ensure it’s a deferred fixed annuity. Only fixed annuities provide you with a guaranteed rate of return.

A fixed-indexed or variable annuity's interest rate depends on market conditions. If you don't want Wall Street determining how much your deferred annuity will earn, be sure to purchase a deferred fixed annuity.

Ideally, you would time your annuities so that you have a continuous income stream. For example, if you choose to buy a deferred annuity with a 10-year term, your immediate annuity should also have a 10-year term. That way, when the immediate annuity contract ends, you'll be able to annuitize the deferred annuity and begin receiving your next stream of payments.

This setup lets you have some of the advantages of both immediate and deferred annuities.

Right now, you get a steady income stream while your savings grow. Then in the future, you get a second steady income stream from that growth of your savings.

Example Split-Funded Annuity Calculation

Here's an example of how a split-funded annuity could go.

Imagine you’re approaching retirement and have saved $400,000. You want a steady income stream for the rest of your life, so you choose to buy an annuity.

However, instead of putting the entire $400,000 into an immediate annuity, you split the funds between both an immediate and a deferred annuity.

So, let’s say you split your money in half. You use the first $200,000 to purchase a 7-year immediate annuity. This will pay you a steady stream of income for the first 7 years of your retirement.

With the second $200,000, you buy a deferred fixed annuity with a 7-year term, like the Future Fund annuity we offer at Canvas Annuity. At our current annuity rates, you’d earn 3.25% per year on your premium for the 7-year term.

After 7 years, your $200,000 would grow to over $250,000. At that time, you could annuitize it and choose to receive income for the rest of your life.

This strategy lets you enjoy the best of both worlds. You receive income right away courtesy of the immediate annuity. Plus, you ensure that the money in your deferred annuity grows over the 7-year term.

Advantages of a Split Annuity Strategy

The benefits of adopting a split annuity strategy are that you get to have your cake and eat it too:

1. Your immediate annuity gives you a guaranteed cash flow right away
2. Your deferred annuity earns a good rate of return and grows until you cashout
3. The savings in your deferred annuity grow tax-deferred among other tax benefits (but note that you still have to pay income tax on your annuity payouts)
4. There are usually no contribution limits to annuities (like there are with IRAs and 401(k)s), so you can contribute as much as you’d like to both your immediate annuity and deferred annuity

Disadvantages of a Split Annuity Strategy

The main drawback of the split annuity funding strategy is that you’re splitting your funds into two annuities. This means that both annuities are smaller than they would be otherwise.

In particular, you’re losing out on interest by putting your money into an immediate annuity. If you put all of your money into a fixed deferred annuity, all of it would earn interest.

So there’s an opportunity cost: You lose the opportunity to grow your nest egg to its full potential. Let’s return to our earlier example and apply this knowledge. Imagine you didn’t split up your cash, and instead, you put the entire $400,000 in the deferred annuity for a 7-year term at 3.25% interest.

At the end of the 7 years, your money would grow to over $500,000. That’s $100,000 in earnings, and it's about double the growth you'd see if you had split the money between two annuities.

So the drawback of the split annuity strategy is that you lose some potential for financial growth.

In addition to the loss of financial growth, with the split annuity strategy, your money isn't easily accessible.

In fact, this is a drawback of annuities in general. Once you purchase an immediate annuity, you can't access your money again until it's paid back out to you. And with deferred annuities, you will likely incur surrender charges if you try to withdraw your cash early.

That's why it's important to understand your contract and choose options like the Canvas Flex Fund if you need more flexibility.

Who Are Split Annuities for?

The split-funded annuity strategy is not for everyone. It’s really only for individuals who fall into the following two categories:

1) Someone who’s retiring soon and needs the income right away.

2) Someone who has enough cash that they can put some to the side to grow over time.

You should be in both categories if you’re considering a split annuity. If you are about to retire or have already retired and want to begin receiving payouts right away, you may want a split-annuity.

If you still have a few years left before you need the money paid back to you, a fixed deferred annuity is usually a better choice. Additionally, a split annuity only really works for those who have enough money to split.

If you don’t have enough cash upfront, it would be better to keep it all together in a deferred annuity so that it accumulates in value.

If you’re not sure whether the split annuity strategy is for you, consider consulting with a financial advisor. A financial professional can help you think through the various options for your circumstances.

And always review your contract carefully and seek legal advice if you don't understand your contract’s terms.

Annuities Are the Safe Retirement Option

Annuities help people feel secure about their finances as they enter retirement. They’re the only insurance products that guarantee a stable retirement income stream for life.

If you’re looking for a way to supplement your retirement savings or social security payments in retirement, consider an annuity. There are several different types of annuities so it is important to compare all possible plans.

Split funding is one way to cover your bases so you get an income stream starting now while you also enjoy the benefits of a deferred annuity.

Keep in mind that split-funded annuities don't earn as much money as deferred annuities.

Unless you really need the income, it's usually better in the long-run to opt for a deferred annuity.

Feel stuck? Our friendly, licensed representatives can help you understand how annuities can help you support your retirement plans.

Reach out today to find out about the great rates available for Canvas Annuity products.