What Is Annuitization?
Let me explain annuitization directly: it's the process where you convert your annuity investment into a series of periodic income payments. You can set this up for a specific period or for your entire life as the annuitant. Depending on your contract, these payments might go just to you or to you and a surviving spouse in a joint life setup. You can also arrange for beneficiaries to get a portion of the remaining annuity balance if you pass away.
Key Takeaways
- Annuitization converts an annuity investment into periodic income payments.
- You can annuitize for a specific period or for the annuitant's lifetime.
- Payments can be made to the annuitant alone or to the annuitant and a surviving spouse in a joint life payout.
How Annuitization Works
The idea of annuitization has been around for centuries, but life insurance companies turned it into a formal contract for the public in the 1800s. When your insurer draws up the annuity contract, they calculate the payout amount based on key factors like your current age, life expectancy, and the projected interest rate they'll credit to your annuity balance. This calculation sets the payout rate, determining how much income you'll receive. By the end of the payment period, the insurer returns your entire annuity balance plus interest.
The payment period could be a fixed timeframe or tied to your life expectancy. If they estimate you'll live 25 more years, that becomes the period. The big difference with a lifetime option is that if you outlive that expectancy, the insurer keeps paying until you die—they take on the risk of your extended longevity. That's the core insurance element here.
Annuity Payments Based on a Single Life
If your annuity is based on a single life, payments stop when you die, and the insurer keeps any remaining balance. For joint lives, payments continue until the second person dies, but the payout amount is reduced to account for the added longevity risk. You can designate a beneficiary to receive the balance via a refund option, choosing periods like 10 years where, if you die within that time, they get the proceeds. A lifetime refund is possible, but longer refund periods mean lower payout rates.
Changes to Annuities in Retirement Accounts
In 2019, Congress passed the SECURE Act, which updated rules for retirement plans with annuities. It makes annuities more portable—if you switch jobs, you can roll your 401(k) annuity into your new plan. The law also limits lawsuits against retirement plans if they fail on annuity payments, like in bankruptcy cases, through a safe harbor provision that protects the plans, not the annuity providers.
What Is the Stretch Rule for Inherited IRAs?
The SECURE Act ended the stretch provision for inherited IRAs. Previously, beneficiaries could spread required minimum distributions over their lifetime to minimize taxes. Now, non-spousal beneficiaries must withdraw everything within 10 years of the owner's death.
At What Age Can You Annuitize?
You can sign an annuity contract if you're 18 or older—there's no upper age limit.
Is It a Good Idea to Annuitize?
Whether annuitizing makes sense depends on your goals and how much risk you're comfortable with. If you want a guaranteed income stream in retirement, especially if you think you'll live longer than average, an annuity could fit. But remember, they often come with high fees and rigid rules, so explore other options first.
The Bottom Line
With an annuity, you're contracting with a life insurance company: you pay a lump sum or series of premiums, and they convert those funds into periodic payments either right away or later. That's annuitization in action, providing a structured way to turn savings into income.
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