Annuitization Method

Annuitization Method

Investopedia / Mira Norian

What Is an Annuitization Method?

The term annuitization method refers to an annuity distribution structure. Annuities are financial contracts distributed by financial institutions that allow individuals to invest money over a period of time to give them a source of income in the future—normally during retirement. Annuity contracts outline the method of payment. These options allow annuitants to receive lifetime payments or period certain options.

Key Takeaways

  • The annuitization method is a distribution structure outlined in annuity contracts.
  • The method of payment kicks in during the annuitization phase, which is the point at which the investor begins to receive payments.
  • Investors can opt for lifetime payments or period certain options through systematic withdrawals or lump sums.
  • Annuitants who choose the life option are guaranteed income over the entirety of their lifetime but risk losing any remaining balance if they die earlier than expected.
  • Period certain options guarantee payout to the annuitant and their beneficiary after they die up to a certain period.

Understanding Annuitization Methods

As mentioned above, annuities are financial contracts offered by financial institutions and insurance companies. These contracts allow individuals to invest regular monthly payments or a lump sum amount. Individuals can choose between immediate or deferred annuities.

Immediate annuities allow individuals to save with a lump-sum amount for payout, usually within a year. Deferred annuities normally involve monthly payments where the money is saved for a future date, usually for retirement.

The period of time when an individual starts receiving payments is called the annuitization phase. Once someone reaches this point in their contract, the entire amount of money saved is effectively converted into a stream of income. The way the annuitant chooses to receive this income is called the annuitization method. The annuitant can choose to receive payments through a life option or period certain options.

The insurance company guarantees the income stream in a life option for the entire life of the annuitant. Going this route should be risky, especially if the investor dies before expected, which means the remaining balance is forfeited to the insurance company. Most annuities, however, offer period certain options or spousal coverage, which reduces the risk of forfeiture in the event of an earlier-than-expected death.

Annuities are commonly taxed as ordinary income.

Special Considerations

The annuitization phase is the point at which the annuitant starts to receive payments from the annuity. This period is also known as the annuity phase. It comes after the accumulation phase, which is when the money is originally invested in the annuity.

After retirement, annuities are rolled over from the accumulation phase to the annuitization phase, providing income for retirees. The more someone invests in the annuity, the more they receive when the annuity reaches the annuitization phase.

Types of Annuitization Methods

The annuitization phase is the point at which the annuitization method comes into play. Annuitants can choose between regular monthly withdrawals or they can choose to receive a lump-sum payment from their annuity.

With the systematic withdrawal schedule, the annuitant chooses the amount they want to receive each month until the balance in the annuity account runs out. Lump-sum payments, on the other hand, involve a specific sum of money paid out all at once.

As mentioned earlier, there are a few options available to the annuitant when it comes to their annuitization method. The following are some of the most common types.

Life Option

This 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.

Investors should keep the risks in mind. If an annuitant dies earlier than expected, the insurance company gets to keep the remaining balance in the annuity. The remaining balance does not go to their beneficiaries unless a rider is purchased. But if the investor lives longer, they will continue to receive money until they die.

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.

Period Certain Option

The value of the annuity is paid out over a defined period of time of your choosing for the period certain annuitization method. This could be for 10, 15, or 20 years. Unlike the life option, this is still the case if the annuitant dies. This means that if someone elects to receive payments under a period certain option for 15 years but dies after 10, the contract guarantees to make payments to the beneficiary for the remaining five years.

Article Sources
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