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  • Updated: December 22, 2022
  • 12 min read time
  • This page features 8 Cited Research Articles
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APA Schell, J. (2022, December 22). Annuitization. Annuity.org. Retrieved January 28, 2023, from https://www.annuity.org/annuities/annuitization/

MLA Schell, Jennifer. "Annuitization." Annuity.org, 22 Dec 2022, https://www.annuity.org/annuities/annuitization/.

Chicago Schell, Jennifer. "Annuitization." Annuity.org. Last modified December 22, 2022. https://www.annuity.org/annuities/annuitization/.

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What Is Annuitization?

Annuitization means converting the lump sum premium used to purchase an annuity into a stream of income payments. This is usually a permanent process in which the annuity owner elects to receive regular income payments according to the schedule outlined in their annuity contract.

Many economists and financial experts suggest that people use a portion of their retirement savings to purchase income annuities as replacements for pensions, which have long been a means of guaranteeing regular income in retirement.

The lifetime income these insurance products provide protects retirees from outliving their savings and frees them to spend their remaining funds as they see fit — without worrying about making the money last.

“Annuitization is good, but you give up a great deal of control, and it isn’t very popular amongst retirees,” said Jonathan Summers, senior annuity consultant at Senior Market Sales. “It ends up feeding some of the horror stories of annuities for those that don’t know the repercussions when they annuitize an asset.”

Summers said a lot of the new developments in annuities over the course of the last decade have been focused on avoiding annuitization of annuities. These include the introduction of riders, or contract provisions, to provide income without requiring annuitization. Summers said the main reasons people buy annuities now are safety and growth, rather than income.

How Often Are Annuities Annuitized?

Only about 5% of all annuities sold in the United States in 2018 were annuitized, according to figures provided to Annuity.org by the LIMRA LOMA Secure Retirement Institute. This means that roughly 95% were not irrevocably converted into a stream of payments.

“I would say the reason why is that a lot of policies are purchased as insurance,” said Summers. “It’s there if and when they need it. A lot of other products that we write that aren’t annuitized, it’s not for income. It’s more for safety and growth. And if we need it, we’ll get after it. We take withdrawals out.”

Summers said many people take permissible withdrawals from their annuities without annuitizing them.

How Does Annuitization Work?

When you annuitize your annuity contract, you’re turning over the premiums you’ve paid into the annuity to the insurance company that issued your contract. In return, you’ll receive a guaranteed stream of income payments.

Once you elect to annuitize your contract, you cannot reverse your decision. You also won’t be able to withdraw or otherwise access any of the money in the annuity besides what you receive in income payments.

You can choose how long you want to receive payments for after you annuitize. You’ll likely have the option to choose a set number of years for the payout. Most people, though, choose a lifetime income annuity that pays out each month for as long as they live.

Annuity income payments are only partially taxable. The payments are made of both taxable income and the nontaxable return of your principal amount. Once your entire principal has been repaid, you’ll receive the same income each month. However, these payments will be fully taxable.

A married couple annuitizing a contract can choose a joint-life payout. This means that after one spouse passes away, the surviving spouse will continue to receive the same income each month.

Some annuity providers also offer a cash refund option. If the annuity holder passes away before the full premium has been repaid, the difference will go to a named beneficiary.

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Pros and Cons

Like many financial decisions, annuitization of annuities has benefits and disadvantages, which should be considered when you’re planning for retirement. The main benefit is that the income payments are guaranteed for as long as the annuitant wishes, including for life. That said, the longer the payment period, the smaller the fixed payment.

This stable income can help cushion your retirement savings against the effects of inflation, according to licensed life insurance agent Brad Cummins. “Having such an investment alternative within your portfolio highly decreases the risk of losing out huge bucks due to volatility and other factors,” Cummins said.

One downside is that, barring any added riders or added contract provisions, an income annuity’s payments cease upon the death of the annuity holder and potentially his or her spouse. “You can name a secondary annuitant, but ultimately if you die early, and your secondary annuitant dies early, you probably left money on the table,” said Certified Financial PlannerTM Kevin Lao. “However,” Lao said, “this is a small price to pay to guarantee a lifetime of income without worrying about what the stock market is doing daily.”

For participating annuities, such as lifetime annuities, if the annuitant dies before the cash balance has been spent, the insurance company uses the money to pay other annuitants from the pool of participants who outlive their cash balances. This process is known as mortality credits, and it is why annuity issuers are able to continue making payments to people who live longer than expected. Like other types of insurance, annuitized money is pooled to spread risk.

The other disadvantage for many people is that once an annuity is annuitized, the cash value of the purchase is gone. There is no way to access the underlying principle or get a refund. The main alternative here is to sell future annuity payments to a third party at a discount.

Finally, once an annuity enters the annuitization or payout phase, the accumulation phase stops. During the accumulation phase, the cash value of the annuity can increase according to the investment strategy detailed in the annuity contract.

What Are My Payout Options With Annuitization?

When you annuitize your contract, you can choose from several options for how to receive your income payments. Because one of the main benefits of annuities is income you can’t outlive, most annuitants opt for a lifetime payment schedule.

If you choose a lifetime payout, your payment amount will be determined by your life expectancy. The longer you’re expected to live, the lower your payment will be. You’re not guaranteed to receive a full return on your investment, but you are guaranteed to continue receiving payments for as long as you live, even after the cumulative payments exceed the accumulated value of your annuity.

The other options for annuitization payouts are fixed payment schedules. You can choose a fixed amount, also known as a systematic withdrawal system, in which you select the amount of money you want to get each month. You’ll continue to receive that amount until you run out of money.

You can also choose a fixed period, sometimes called a Period Certain annuitization. This means you choose a period of time to receive the payout, usually between 10 and 20 years. If you pass away before this period ends, the remaining payments will go to your named beneficiary.

When Is the Best Time To Annuitize?

Summers said most annuity contracts will specify a deadline for deciding when to annuitize. The deadline is somewhat unlimited because it’s usually by the age of 95, according to Summers. If you haven’t annuitized by then, the contract will annuitize at that age. Some contracts don’t allow annuitization for the first five years, he added.

“Different companies with different products will have it done differently,” Summers said. Some annuity contracts provide a window of time in which the money can be annuitized before it’s put into a lockdown period.

Besides the deadline your provider gives, deciding when to annuitize comes down to your individual situation. “There is no best time for everyone,” said Elle Switzer, Director of Annuity Product Management at CUNA Mutual Group. “Annuitization is generally a retirement strategy to guarantee income for life, but not all consumers will decide to start income right when they retire.

Alternatives to Annuitization

By law, all annuities must allow for an annuitization option. People who don’t annuitize have several other options, according to the provisions of their annuity contracts.

Lump Sum Payment

At the end of a designated surrender period, during which access to the funds is restricted — typically five, seven or 10 years — the annuity owner can cash out the annuity and take the funds in the account, along with any earnings as long as the annuity holder is at least 59 ½ years old.

Roll the Money Over

Some annuities give the owner a window of time after the annuity matures to decide whether to take the money out. If the money is left in the annuity, it may create a new contract, restarting the surrender period.

Is Annuitization Right for Me?

Whether to annuitize is a decision that is personal to each person. Before executing an annuitization, make sure it is the right course of action, given your financial circumstances and liquidity needs.

Among the factors you should consider:
Financial Objectives
Do you need guaranteed income for life, or is access to your underlying funds more important?
Total Value of Your Assets
If you have enough savings to keep some funds liquid, it may make sense to annuitize a portion of your assets.
Tax Treatment
Annuities grow tax-deferred, meaning the funds are not taxed as income until they are withdrawn. If you withdraw the funds all at once, there will be a larger tax payment due.
Flexibility
Annuitization eliminates flexibility.

Other factors to consider include how long you expect to live. If you are in poor health and have a shorter life expectancy, annuitization may not make sense. On the other hand, if your life expectancy is short because of actuarial estimates, your annuity payments will be larger than those for a person with a long life expectancy.

In addition, you might not think gender plays a role in this decision, but it’s relevant. On average, women have longer life expectancies than men. As a result, annuitization is more expensive for women. An exception is when annuities are purchased inside 401(k) retirement plans, where the law requires equal treatment.

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: December 22, 2022

8 Cited Research Articles

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