What Is the Annuitization Method?

The annuitization method is a type of annuity distribution structure that gives the annuitant periodic income payments for the rest of their life or for a specified period of time. This payment type contrasts with the systematic withdrawal method, in which the annuitant chooses the amount they would like to receive each month until the balance in the annuity account runs out.

Key Takeaways

  • The annuitization method is a distribution structure that gives periodic income payments to the owner of an annuity.
  • The periodic payments are for the remainder of the annuitant's life or for a predetermined period of time.
  • The risk of choosing the life option is that the annuitant dies sooner than expected, and the insurance company keeps the money in the account.
  • While the life option pays out as long as the annuitant is alive, the joint-life option keeps paying the spouse if the annuitant passes away.
  • The payments from the joint-life plan are lower compared to the life option because the numbers are based on the life expectancy of both spouses.

Understanding the Annuitization Method

Upon annuitization of their account, the annuitant effectively converts the entire savings in the account into an income stream. If they choose the life option, the income stream is guaranteed by the insurance company to last the rest of the annuitant's life, even if they should live much longer than originally expected.

Of course, the risk in choosing the life option is that, should the annuitant die sooner than expected, they will not receive the full value of the annuity account—the insurance company gets to keep the remainder of the account upon the annuitant's death. Most annuities, however, offer period certain options or spousal coverage, which can reduce the risk of the annuitant's funds not being sufficiently paid out because of an earlier-than-expected death.

The annuitization phase, also known as the annuity phase, is the period when the annuitant starts to receive payments from the annuity. This period comes after the accumulation phase, which is when the money is invested into the annuity. After retirement, annuities are rolled over from the accumulation phase to the annuitization phase, providing income for retirees. The more that was originally invested into the annuity, the more will be received when the annuity is paid out.

The annuitization phase is the time when the choice of method for payment comes into play: the annuitization method, the systematic withdrawal schedule, or the lump-sum payment. The annuitization method comes with the following considerations.

Life Option vs. Joint-Life Option

The life option typically provides the highest payout because the monthly payment is calculated only on the life of the annuitant. This option provides an income stream for life, which is an effective hedge against outliving your retirement income.

The joint-life option continues to pay the spouse in the event of the annuitant's death. The monthly payment from a joint-life annuity is lower than that of the life option because the calculation is based on the life expectancy of both spouses. With the period certain option, the value of the annuity is paid out over a defined period of time of your choosing, such as 10, 15, or 20 years. Should a person elect a 15-year period certain and die within the first 10 years, for example, the contract is guaranteed to pay the beneficiary for the remaining five years.