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Here's what you need to know about annuitization.

If you’re on the cusp of retirement or just looking for extra income, annuitization could help you. Annuitization converts an annuity investment into a stream of regular payments. With an annuity, a financial product that makes regular payouts after a specified amount of time, your investment can pay off quickly. We explain the math behind it and can help you decide if it might work for you.

Annuitization Basics 

Here's what you need to know about annuitization.

Annuitization converts an annuity investment into regular payments. It’s an idea that’s been around for hundreds of years, but life insurance companies picked it up in the 1800s. If you make a lump-sum payment to those companies, they’ll distribute it over a set schedule. Those payments can be made over a specific period or over a lifetime.

An annuity servicer holds and invests the funds within an annuity. They only make regular payouts to the annuity holder once the annuitization process has been completed. 

Annuity investments follow a specified path: Purchase the annuity, move through the accumulation phase, then pay it out.

The Numbers 

Once you decide to start receiving regular payments via your annuity, you’ll talk to your annuity holder about a payment structure. That will determine the amount and frequency of your annuity payments. 

There are several options for annuity payouts:

  • Life Option: You can elect to receive annuity payments for the duration of your life, after which your beneficiary may be eligible to receive payments. 
  • Joint-Life Option: This allows annuity payments to be transferred to a spouse once the annuity holder passes 
  • Period Certain: You can receive annuity payments for a fixed amount of time, such as 10 or 15 years. After that period expires, payments will cease. 
  • Lump-sum: You can also opt for a lump sum payment, though that defeats the purpose of an annuity. It is meant to provide a steady stream of income throughout retirement. 
  • Systematic Withdrawal: You’ll decide on a monthly payment amount and it will continuge. as long as you have funds in your annuity. 

Annuity payments are calculated based on a variety of factors, from age to gender to life expectancy. The payout option you select will also determine the payment amount. 

Different types of annuities may affect the amount and frequency of your payouts. First, fixed annuities offer a fixed payment for a specified amount of time (or for a lifetime). Alternately, variable annuities have payouts dependent on the annuity’s performance on the market. 

Pros and Cons of Annuitization

Here's what you need to know about annuitization.

Annuities can offer a sort of insurance policy against running out of money in retirement. But just as there are pros and cons to using annuities, there are benefits and drawbacks to consider when annutizing them.

If you’re saving for retirement, you’re likely using a 401(k), an IRA, an investment portfolio, or a combination of all three. However, they aren’t a guaranteed stream of income for the duration of your retirement.  Once annuitized, an annuity with a life payment option can provide a steady source of income throughout your retirement. 

Annuities also offer flexibility. Annuity holders have various options for payout structures, which can help you select the most financially beneficial option for you. 

The bad news is that annuities aren’t liquid. That could pose an issue if the annuity holder needs quick access to their money. Also, there’s no going back once you annuitize. The insurance company wants to minimize risk, which is why this complicated transaction is tough to undo once it’s set in motion.

Choosing the right payout option can also be tough. If you choose the life payout option, but you die earlier than your life expectancy,  your spouse and/or heirs may lose out. A joint-life payout option would fix that, but you have to opt for it. Meanwhile, if you live longer than expected, you may outlive your annuity payments. 

Annuities vs. Life Insurance 

While both are financial products offered in many cases by insurance companies, they are actually inverse in nature.

A life insurance policy offers compensation to one’s beneficiaries in the event that they die at a young age. Meanwhile, an annuity (that’s been annuitized, of course) offers a steady stream of income if one’s life expectancy outlasts their income. 

However, annuitizing is just an option. Annuity holders don’t have to do it and can take the money in their annuity elsewhere. You can cash out and make lump-sum withdrawals, but nobody is forcing you into a payment structure.

The Bottom Line 

Annuitization converts your annuity investment into a stream of regular payments. There are many payout options, which can help you protect yourself and your assets in the event that you live longer than expected.

However, annuities aren’t without their drawbacks, so be sure to carefully consider your financial goals and other factors before signing on the dotted line. 

Retirement Tips

  • If you aren’t sure if annuitization is the right strategy for your retirement, a financial advisor may be able to help. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • Do you know how much you’ll need for retirement? Do you know what your 401(k) will be worth when you retire? How much will you rely on Social Security once you stop working? SmartAsset’s retirement guide can help answer these questions and lay the foundation for your retirement plan.

Photo credit: ©iStock.com/Casper1774Studio, ©iStock.com/ijeab, ©iStock.com/Jirapong Manustrong

Rachel Cautero Rachel Cautero writes on all things personal finance, from retirement savings tips to monetary policy, even how young families can best manage the financial challenges of having children. Her work has appeared in The Atlantic, Forbes, The Balance, LearnVest, SmartAsset, HerMoney, DailyWorth, The New York Observer, MarketWatch, Lifewire, The Local: East Village, a New York Times publication and The New York Daily News. Rachel was an Experian #CreditChat panelist and has appeared on Cheddar Life and NPR’s On Point Radio with Meghna Chakrabarti. She has a bachelor’s degree from Wittenberg University and a master's in journalism from New York University. Her coworkers include her one-year-old son and a very needy French bulldog.
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