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How to Choose Your Annuity Payout Option


As an owner of an annuity, you have multiple options when it’s time to start withdrawing from it. Your decision can drastically affect the level of income you and your beneficiaries receive from your annuity. To help decide which route is best, there are a handful of pros and cons of you’ll want to review for each available payout option. You may even want to take advantage of the experience of a financial advisor as you make these critical decisions. Doing so could be especially beneficial for your long-term retirement plans.

Immediate vs. Deferred Annuities

There are two primary types of annuities: immediate and deferred. Immediate annuities start distributing monthly income right after you buy it. Deferred annuities receive one or more deposits and let the money grow tax-deferred over time. At some point in the future, the owner of the annuity will decide to start taking withdrawals.

Both types of annuities have decisions to make about their annuity payout options. Deferred annuities have more annuity options than immediate annuities because once you’ve annuitized your account, you cannot change your decision. Therefore, making an informed decision is incredibly important during this time.

Annuity Payout Options

The three most common annuity payout options are annuitization, systematic withdrawal and lump sum distribution. However, there are additional annuity payout options that are variations upon these basic strategies. Here’s a breakdown of each choice:

Single Life and Life-Only

This option provides the highest monthly payout of any annuity payout option. The entire account balance is converted into a stream of payments that will last for the rest of the account owner’s lifetime. This option ensures that the account owner will always have a monthly payout, no matter how long they live. The downside is that if the owner dies relatively quickly, their beneficiaries are left with nothing.

Life Annuity With Period Certain

A period certain annuity option guarantees that the annuity will provide monthly income for a minimum number of years, even if you pass away before then. This choice does reduce the monthly payment, but it addresses the concern of passing away too quickly after choosing the option.

Joint and Survivor Annuity

The joint and survivor annuity option is typical for couples who want to ensure that the surviving spouse will continue to receive payments after the other spouse dies. Depending on the contract, the surviving spouse may receive the full payment or a lower percentage. This could typically be 50% or 75% of the original amount.

Lump Sum Payment

Annuity Payout Options

A lump sum payment enables the owner of the annuity to cash out the annuity and takes all of the money immediately. While this does offer the investor more flexibility, this increases the chance of the money running out before they pass away.

Additionally, this option can result in a larger tax bill for the annuity’s growth. This should come as no surprise, considering the IRS will hit you harder as your taxable income for the year piles up.

Systematic Annuity Withdrawal

This method is similar to annuitization, but it does not guarantee lifetime income. Instead, the investor makes automated withdrawals of a certain amount on a fixed schedule, which can result in them running out of money before the end of their life.

Penalty-Free Withdrawals

During the early years of an annuity, the insurance company will likely charge a surrender fee on the amount withdrawn. Surrender fees usually apply during the first six-to-eight years. They can start out high and typically decrease each year until they are fully eliminated. Some annuities allow a penalty-free withdrawal of up to 10% of the annuity’s value, which avoids these fees altogether.

Which Annuity Payout Options Are Best?

The best annuity payout options depend on your personal situation and your goals. With multiple strategies to choose from, annuities can be a valuable tool in your retirement income planning. Here are a couple of scenarios where the account holder may choose a different option than traditional annuitization:

  • Being in Bad Health: Someone in bad health may choose to make periodic withdrawals or a life annuity with a period certain. The periodic withdrawals will keep the remainder of the balance available for beneficiaries. Period certain annuitization ensures that payments are made every month for a minimum period of time, even if the original account holder passes away first.
  • Spouse Has Limited Retirement Savings: The joint and survivor annuity option is chosen when a spouse wants to ensure that their spouse will continue to receive annuity payments, even if they pass away first. This option is ideal when one spouse worked outside the home and has the majority of the retirement assets in their name.

How Are Annuity Distributions Taxed?

Annuity Payout Options

Distributions from your account are generally considered a mix of growth and principal. The principal portion of your distributions are not taxed because you are withdrawing the money that you contributed. However, you are taxed on the growth portion of your withdrawals.

For example, say that your annuity provides a monthly income of $300 per month. Of this amount, $225 is a return of your principal and $75 is from the growth of your account. Only the $75 of growth is considered taxable income.

Annuities are designed for retirement income, and the earnings grow tax-deferred. This is a huge benefit, as it enables your money to stay together and grow faster. Like a retirement account, if you withdraw from your annuity before age 59.5, the IRS charges a 10% penalty on the amount withdrawn. Try to avoid doing this at all costs.

Bottom Line

Annuities provide a valuable source of retirement income that you cannot outlive. As an annuity buyer, you have many choices when it comes to your annuity payout options. Once your account becomes annuitized and you start receiving monthly payments, the decision cannot be reversed. It makes sense to explore all of your options and discuss them with a professional to ensure that you understand the pros and cons of each.

Tips for Annuity Investors

  • With so many annuity payout options to choose from, it can be a challenge to know which one is right for you. Financial advisors can offer impartial advice to match you with the right strategies. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Calculating how much retirement income you need for your ideal lifestyle is one of the first steps in retirement planning. Our retirement calculator helps define your goals based on the expected age of retirement, income sources, savings rate and more.

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