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A split-funded annuity involves investing part of your money in an immediate annuity, which begins paying you right away, and the rest in a deferred annuity. The deferred annuity allows your funds to accumulate, so your payout is better down the line.
There are all kinds of strategies to consider and choices to be made when investing and saving for retirement. This holds true for most financial products, including annuities.
One basic choice when purchasing a single premium annuity is whether to get an immediate annuity or a deferred annuity.
As the name suggests, the holder of an immediate annuity begins receiving payments within a short time, typically within a year. A deferred annuity pays years after the purchase date. This gives the funds time to accumulate and leads to larger payments.
If you’re about to retire and want to purchase an annuity, the simple approach would be to buy an immediate annuity so you can start receiving payouts right away.
But there’s another option in that circumstance: a split-funded annuity. This strategy allows you to receive payment right away from an immediate annuity but also benefit from the higher payouts of a deferred annuity.
What Is a Split-Funded Annuity?
With a split-funded annuity you use part of your money to purchase an immediate annuity while the rest goes toward a deferred annuity. This allows you to receive payments from the annuity right away and collect bigger payments starting at some point in the future after the money has accumulated tax deferred. Some call this strategy a split annuity or combination annuity.
Forbes gives this hypothetical example:
Take $500,000 in savings and split it in half. Put $250,000 in an immediate annuity that pays for 10 years. The rest goes into a tax-sheltered, deferred annuity with a potential return on investment of 5 percent to 7 percent. In 10 years, the deferred annuity grows to $500,000. At that time, you do another split. An income rider can help achieve guaranteed income for life.
How much you use for each kind of annuity could depend on several factors. But generally, you may consider directing more at the deferred annuity than the immediate. You should run various scenarios with your investment adviser to determine exactly how to split your annuity.
Goal of Splitting Your Funds
The bottom line is that while you are receiving payments from the immediate annuity, the rest of your money in the deferred annuity is growing, replenishing your savings while you are paid.
The goal usually is that by the time the payout begins on the deferred annuity, it will have accumulated enough funds that the balance is equal to your original sum of money, or starting principal.
When you are ready to begin receiving payments from your deferred annuity, you could do another split and put some of the money into an immediate annuity and defer the rest. You would be older, so your payouts would be better because annuity rates are determined, in part, by life expectancy. The shorter your life expectancy, the higher the payouts.
This usually works only when you have enough money to purchase the split-funded annuity to make the formula work to your advantage. And you should also be mindful and ask questions about any additional fees and costs that come from making another split.
7 Cited Research Articles
- Farm Tax Network. (2012, June 5). New Guidance on Splitting Annuities to Defer Income. Retrieved from https://www.claconnect.com/WorkArea/DownloadAsset.aspx?id=4584
- Hicks, C. and Moeller, P. (2019, February 25). 15 Things You Need to Know Now About Annuities. Retrieved from https://money.usnews.com/investing/investing-101/articles/things-you-need-to-know-now-about-annuities
- Insured Retirement Institute. (n.d.). Glossary of Annuity Product Terms. Retrieved from https://www.irionline.org/research-and-education/educational-resources/annuities-glossary
- Joseph, C. (n.d.). How Does a Split Annuity Work? Retrieved from https://budgeting.thenest.com/split-annuity-work-4291.html
- Kagan, J. (2018, May 25). Split-Funded Annuity. Retrieved from https://www.investopedia.com/terms/s/split_funded_annuity.asp
- Okolo, MK. (2019, February 22). 7 Common Retirement/Tax Mistakes and How to Avoid Them. Retrieved from https://www.forbes.com/sites/impactpartners/2019/02/22/7-common-retirementtax-mistakes-and-how-to-avoid-them/#47bff61c2148
- Smith, A. (2017, July 27). What Is a Split Annuity? Retrieved from https://pocketsense.com/split-annuity-7482107.html