Annuity owners can customize their contracts with a range of payout options to ensure consistent income, whether for immediate needs or as part of a retirement income plan. Understanding the various annuity payout structures available to you will help you make an informed choice that aligns with your financial goals.
When you acquire an annuity, one of the primary decisions you’ll need to make is regarding your payout structure. This will determine not only when you start receiving payments but also how they are distributed over time.
Starting Your Payments
Deciding when to start your annuity payments is a crucial step, reflecting your immediate financial needs and future plans. Whether you’re looking for a prompt income source or planning for future security can influence your choice between immediate or deferred annuities.
Choosing Your Payment Duration
The duration of your annuity payments can significantly impact your financial stability in the years to come. By assessing how long you’d like to receive these payments, whether for a fixed period or for life, you can tailor an annuity structure that aligns with your long-term aspirations and security.
Common annuity payout structures include:
- Single Life/Life Only
- Life Annuity with Period Certain
- Joint and Survivor Annuity
- Lump-Sum Payment
- Systematic Annuity Withdrawal
- Early Withdrawal
When purchasing an annuity contract, you’ll first decide when you want to receive your payments. Are you hoping to receive payments right away to cover immediate needs, or are you saving for your future retirement? The answer will help you choose whether the payout structure of an immediate annuity or deferred annuity best suits your needs.
| Annuities by Payment Types | Payments Begin | Ideal For |
| Immediate Annuity (Income Annuity) | Within a year of purchase | Retirees or people expecting to retire soon who will use the payments as a supplementary income stream |
| Deferred Annuity | Retirement or another time in future | Buyers who value tax-free growth on their investment to create larger payments during their future retirement |
Immediate Annuity (Income Annuity)
As the name suggests, immediate annuities begin to pay out immediately or within a year of purchase. The most basic type of immediate annuity, the single premium immediate annuity (SPIA), converts a lump sum premium payment into a stream of income in a year or less.
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Regardless of when you begin receiving payments from these products, immediate annuities are designed to create an income stream for a set period.
Deferred Annuity
Deferred annuities delay payment to the annuitant for many years after they’re purchased. Usually, the payments are deferred until retirement. In the interim, the annuity grows as interest accumulates tax-free. The longer the time between the purchase and the start of payments, the more the annuity will grow and the larger the eventual payments will be.
The duration of the income stream is another important consideration, with many payout options available to choose from depending on the type of annuity you choose. Again, consumers can structure the payout schedule to best meet their needs. Below are the most common options.
Single Life/Life Only
Also called a straight life or life-only annuity, a single life annuity lets you receive payments throughout your life. Unlike other options that include beneficiaries or spouses, a single life annuity limits payments to the annuitant’s lifetime without a survivor benefit. If you pass away before receiving your full premium, the insurance company keeps the balance. To decrease the chances of this happening, consider buying a life annuity with a period certain.
Life Annuity with Period Certain (Fixed Period/Guaranteed Term)
Period certain annuities resemble straight life annuities but have a minimum set payment duration, often 10 or 20 years, even if the annuitant passes away. If the annuity holder dies before this period ends, a beneficiary or the annuitant’s estate receives the remaining payments. Adding the period certain reduces the amount of your monthly payments to cover the extended time guarantee.
Joint and Survivor Annuity
Joint and survivor annuities ensure payments will continue for the lifetimes of both the annuitant and another person, usually a spouse. This option results in smaller individual payments than you would receive with a straight life annuity or a life annuity with a period certain of the same amount.
You may choose to add a period certain and designate a beneficiary who would receive the death benefit if both annuitants die before the period ends.
Lump-Sum Payment
This option allows the annuitant to receive the entire value of the annuity at one time. This choice can lead to a significant tax burden since the IRS mandates income tax payments be made in the distribution year.
Systematic Annuity Withdrawal
A systematic annuity withdrawal lets you decide the dollar amount and frequency of payments without considering the income stream’s duration. Thus, there is no guarantee that the funds will last through the remainder of your life; how long payments last depends entirely on the cash value of your contract.
Early Withdrawal
Electing to withdraw money from your annuity before you reach the age of 59 ½ results in a 10% government penalty plus any applicable taxes. If that withdrawal is within five to seven years of purchasing the annuity, you may also owe the annuity provider a surrender charge of up to 20%, depending on how much time has passed since the purchase.
Understanding the Lump Sum Payout Option
When it comes to annuities, one of the most significant considerations you must make is how you want to receive your payments. While some people want a consistent source of income over time, others prefer a big sum payment. Understanding the lump sum payout option is critical for making an informed selection that is consistent with your financial objectives and circumstances.
1. Flexibility and Control: One of the key advantages of choosing a lump sum payout is the flexibility and control it offers. By receiving a large sum of money upfront, you have the freedom to allocate the funds as you see fit. Whether you want to invest in a new business venture, pay off debts, or make a significant purchase, the lump sum provides you with the means to do so. This option allows you to have greater control over your financial future and enables you to tailor your investments to suit your individual needs.
2. Tax Implications: It is important to consider the tax implications associated with a lump sum payout. While annuity payments are typically subject to income tax, a lump sum distribution may result in a higher tax liability. The entire lump sum is treated as taxable income in the year it is received, potentially pushing you into a higher tax bracket. However, it is worth noting that there are certain strategies and tax planning techniques that can help mitigate the tax burden associated with a lump sum payout. Consulting with a financial advisor or tax professional can provide valuable insights and guidance in navigating this aspect.
3. Opportunity Cost: When deciding whether to opt for a lump sum payout, it is essential to evaluate the opportunity cost. By receiving a large sum of money upfront, you forego the potential growth and compounding benefits that regular annuity payments can offer. If you have a sound investment strategy and believe that the returns you can generate from investing the lump sum will outweigh the benefits of regular payments, then the lump sum option might be more appealing. However, it is important to carefully assess the potential risks and rewards before making a decision.
4. Long-term financial planning: The lump sum payout option can significantly impact your long-term financial planning. While it may provide immediate financial relief or the means to pursue certain goals, it is crucial to consider the long-term implications. Will the lump sum be sufficient to meet your future financial needs? Are you equipped to manage and invest a large sum of money effectively? These are important questions to ask yourself when contemplating the lump sum payout option. Creating a comprehensive financial plan that takes into account your current and future financial goals can help provide clarity and guide your decision-making process.
Understanding the lump sum payout option is essential when considering annuities. It offers flexibility and control over your finances, but also comes with tax implications and requires careful evaluation of opportunity cost and long-term financial planning. By weighing these factors and seeking professional advice, you can make an informed decision that maximizes your annuity in advance and aligns with your individual financial objectives.
Lump-Sum vs. Regular Pension Payments
If you are approaching retirement and you are receiving a pension, you may wonder if you should you accept the traditional, lifetime monthly payments or take a lump-sum distribution.
You might be tempted to go with the lump sum for the large single disbursement of money. However, before you make a decision about your financial future, learn how they compare. Each payment strategy has difference financial consequences. Let’s look at the pros and cons of taking a lump sum versus a regular pension payment.
Lump-Sum Payments
A lump-sum distribution of a pension is a one-time payment from your pension administrator. By taking a lump sum payment, you gain access to a large sum of money, which you can spend or invest as you see fit.
“One thing I emphasize with clients is the flexibility that comes with a lump sum payment,” says Dan Danford, CFP, Family Investment Center of Saint Joseph, Missouri. A pension payment annuity “is fixed (occasionally COLA-indexed), so there is little flexibility in the payment scheme. But a 30-year retirement probably faces some surprise expenses, possibly large. The lump sum, invested properly, offers flexibility to meet those needs and can be invested to provide regular income, too.”
They type of your pension payment may affect your children, as well. Consider whether you want to leave something to your loved ones after your death. Once you and your spouse die, the pension payments might stop. On the other hand, with a lump-sum distribution, you could name a beneficiary to receive any money that is left after you and your spouse are gone.
Rolling over a lump sum
Income from pensions is taxable. However, if you roll over that lump sum into your IRA, you will have much more control over it when you remove the funds and pay the income tax on them. Of course, you will eventually have to take the required minimum distributions (RMDs) from your IRA, but that won’t happen until age 73.
“Rolling your pension into an IRA will give you more options,” says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, MA.8 “It will give you more flexibility of investments that you can invest in. It will allow you to take distributions according to your required minimum distribution (RMD), which in many cases, would be lower than your planned pension payments.”
Regular Pension Payments
A regular pension payment is a set monthly payment payable to a retiree for life and, in some cases, for the life of a surviving spouse. Some pensions include cost-of-living adjustments (COLA), meaning payments go up over time, usually indexed to inflation.
Some argue that the main feature people like about lump-sum payments—flexibility—is a reason to avoid them because it can encourage overspending. With a regular pension checks, you don’t immediately have access to a large sum of money.
A 2020 report by the Consumer Financial Protection Bureau found that retirees with pension income were more likely to remain financially stable than those who had cashed out the lump sum. Of those with regular payments, 73% could maintain the same spending levels after five years, compared to only 56% of those who had chosen the lump sum.
A lump sum also requires careful asset management. If you put the money into conservative investments so you don’t lose money, the growth may not keep pace with inflation. However, if you invest in assets that can yield greater returns, you have a higher risk of losses.
“In an environment with low fixed-income interest rates and generally expanding life expectancies, the pension stream is generally the better way to go,” says Louis Kokernak CFA, CFP, founder of Haven Financial Advisors, Austin, TX. “It is no accident that private and public employers are paring back those benefits. They are trying to save money.”
You also need to think about health insurance. In some cases, company-sponsored coverage stops if an employee takes the lump sum payout. If this is the case with your employer, you will need to include the extra cost of health insurance or a Medicare health supplement in your calculations.
A lump sum pension distribution give you your entire pension at once. It offers the flexibility of being able to spend or invest your retirement savings any way you see fit. While a pension annuity offers a fixed monthly income, a lump sum can be used for a range of purposes, including for unexpected medical expenses. If you die early, you can potentially receive more money than you would with regular payments. If invested carefully, a lump sum could also offer a passive income.
Perhaps the greatest risk of cashing out a pension early is the prospect of running out of money. With life expectancies rising, many retirees face the increasing likelihood that they may outlive their savings, especially if they spend it. Studies show that retirees who cash out their pensions are less likely to maintain the same levels of financial stability after five years. A monthly payment offers a steady income for the remainder of one’s life, and in some cases can also be passed on to a spouse.
For some, a lump-sum pension payment makes sense. For others, having less to upfront capital is better. In either case, pension payments should align with your personal goals for your retirement. If you’re not sure which option is best for you, consider speaking with a financial advisor to see whether a lump-sum or regular payment schedule is the best strategy for you.
Risks and Pitfalls to Avoid
When it comes to maximizing your annuity with a lump sum payout, you should be aware of many risks and dangers. While the prospect of obtaining a huge quantity of money all at once may be appealing, this decision should be approached with prudence. Understanding the potential dangers and hazards allows you to make informed decisions that will lead to a prosperous financial future.
1. Market Volatility: One of the key risks associated with a lump sum payout is market volatility. If you choose to invest your annuity in the stock market or other volatile investments, you run the risk of losing a significant portion of your funds. It’s crucial to carefully assess your risk tolerance and consult with a financial advisor before making any investment decisions. Diversifying your investments and opting for a balanced portfolio can help mitigate the impact of market fluctuations.
For example, let’s say you receive a lump sum payout of $500,000 from your annuity. Instead of investing the entire amount in high-risk stocks, you decide to allocate a portion towards low-risk bonds and real estate investments. This diversification strategy can help protect your funds from potential market downturns and provide a stable income stream.
2. Inflation: Inflation is another risk that can erode the value of your lump sum payout over time. While it may seem like a significant sum initially, the purchasing power of your funds can diminish as prices rise. To combat the effects of inflation, consider investing a portion of your lump sum in assets that have historically outperformed inflation, such as stocks or real estate.
For instance, let’s say you receive a lump sum payout of $1 million from your annuity. Instead of keeping the entire amount in a low-interest savings account, you decide to invest a portion in a diversified portfolio of stocks. Over time, the potential growth of your investments can help offset the impact of inflation and ensure your funds retain their value.
3. Lack of Financial Discipline: Another pitfall to avoid is the lack of financial discipline that often accompanies a lump sum payout. It’s easy to get carried away with extravagant purchases or impulsive spending when you suddenly come into a large sum of money. However, it’s important to resist the temptation and develop a sound financial plan.
Creating a budget and sticking to it is essential to ensure your lump sum payout lasts for the long term. Consider setting aside a portion of your funds for emergencies, investing a portion for long-term growth, and allowing yourself some flexibility for discretionary spending. By exercising financial discipline, you can make the most of your lump sum payout and secure a stable financial future.
While a lump sum payout can provide you with immediate financial freedom, it’s crucial to be aware of the risks and pitfalls associated with this decision. Market volatility, inflation, and lack of financial discipline can all pose significant challenges. However, by diversifying your investments, considering inflation-resistant assets, and exercising financial discipline, you can maximize your annuity and set yourself up for a prosperous future.
