Annuitization is the process of converting an annuity investment into a series of periodic income payments. Annuities may be annuitized for a specific period or for the lifetime of the annuitant. The payments might be made solely to the annuitant or extend to a surviving spouse in the case of a joint life arrangement. Annuitants can also arrange for their beneficiaries to receive a portion of the annuity balance upon their death.
Key Takeaways
- Annuitization converts an annuity investment into periodic income payments.
- Annuities can be for a specific period or for the lifetime of the annuitant.
- Payments may go to the annuitant alone or include a surviving spouse in a joint arrangement.
- Beneficiaries can receive a portion of the annuity balance upon the annuitant’s death.
Understanding Annuitization
While the concept of annuitization has historical roots, life insurance companies formalized it into a public contract in the 1800s. Individuals can enter such contracts with insurance companies by exchanging a lump sum of capital for a promise of periodic payments over a specified period or the lifetime of the annuitant.
How Annuitization Works
When a lump sum is received, the insurance company determines the annuity payout amount considering factors like the annuitant’s age, life expectancy, and the projected interest rate to be credited to the annuity balance. This payout amount ensures the return of the full annuity balance plus interest by the end of the specified period.
The payment period could be a pre-defined duration or based on the life expectancy of the investor. If, for instance, the life expectancy is calculated to be 25 years, that becomes the payment period. Distinguishing between a specific and a lifetime period is crucial, as the insurer continues payments beyond the annuitant’s life expectancy until their death, assuming the risk of extended longevity.
Annuity Payments Based on a Single Life
For annuities based on a single life, payments cease upon the annuitant’s death, with any remaining balance retained by the insurer. In joint life cases, payments persist until the death of the second annuitant, typically at a lower payment amount to cover the additional longevity risk.
Annuitants can choose a beneficiary to receive the annuity balance through a refund option. Refund options can vary; the length of the chosen refund period affects the payout rate—the longer the period, the lower the payout rate.
Changes to Annuities in Retirement Accounts
The SECURE Act of 2019 brought significant changes to retirement plans involving annuities. A positive change is the increased portability—allowing for 401(k) annuities to be rolled over into new employer plans. However, the Act also removed some legal risks from retirement plans, limiting account holders’ ability to sue in cases like provider bankruptcy.
Additionally, the Act eliminated the stretch provision for beneficiaries inheriting an IRA, requiring non-spousal beneficiaries to distribute all funds within 10 years of the owner’s death, although exceptions exist. Due to the complexity, consulting a financial professional is advised to navigate these changes.
Related Terms: Annuity, Life Insurance, Life Expectancy, 401(k), IRA.
References
- Congress.gov. “H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019”.
- Society for Human Resource Management. “SECURE Act Alters 401(k) Compliance Landscape”.
