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Annuities provide retirees and near-retirees with a tax-deferred way to supplement their retirement income. By entering into a contract with an insurance company and making a lump-sum payment or a series of contributions, individuals can later receive either a lump sum or regular payouts over time.
Key Takeaways
- Annuity payout options can provide guaranteed income in retirement.
- Each payout option has unique implications for financial security as well as tax obligations.
- Life expectancy and financial needs play a key role in choosing a payout option.
- Understanding the pros and cons of each option aids in making informed decisions.
- Consulting with financial advisors can provide personalized guidance.
What Are Annuity Payout Options?
When you enter into an annuity contract with an insurance provider, you’ll have options for how you’ll receive your payouts. This decision has a significant impact, as it will determine when payouts will start and how long they will last, as well as how much you’ll need to pay in.
At this point and if the policy allows for it, you could also choose to include a death benefit in your policy, which will allow annuity payments to be distributed to an individual of your choice should you pass away. Before you make any decisions, weigh each choice and determine which best fits your financial plan.
Types of Annuity Payout Options
Life-Only Option
If you’re focused on maximizing your income and are comfortable estimating your life expectancy, this option may be for you. The insurance company will pay you as long as you live, with smaller payments if that’s a longer timeframe.
However, as the life-only payout option typically doesn’t include a death benefit, it’s essentially a gamble: if you die before you receive all your payouts, the insurance company may keep the rest. On the other hand, you may be paid more than your annuity is worth if you live longer than you expect.
Joint and Survivor Option
If you want an annuity option that comes with the peace of mind that it’ll take care of a loved one in the case of your passing, consider joint and survivor. This option ensures continued payments to a designated survivor, usually a spouse, if you pass away. The insurer will make payments for as long as either of you is alive.
Note
Payments under this option are typically smaller than under the life-only option.
Fixed Period (Period Certain) Option
Also known as a fixed-term annuity or a short-term annuity, this option provides guaranteed payments for a specified period of time, ranging from five to 20 years. If you die before the specified period, for example, if there are five years left, your designated beneficiary will receive the rest of the money.
Life With Period Certain Option
Similar to the life-only option, this option guarantees payments for as long as you live. There’s one notable difference, however: this option includes a minimum period of payouts, typically 10 to 20 years. If you die before the end of this period, your beneficiary will receive the remaining payments.
Lump Sum Option
With this option, you can elect to receive the entire value of the annuity in one large payment. No surprise, but this comes with repercussions: you’ll have to pay taxes on the whole amount.
Pros and Cons of Different Payout Options
| Payout Option | Pros | Cons |
|---|---|---|
| Life-Only | Provides guaranteed income for life
Potential to earn more if you live longer than expected |
As there’s no death benefit, you run the risk of leaving no payouts to your beneficiary |
| Joint and Survivor | Provides peace of mind as income is guaranteed while either you or your beneficiary is alive | Monthly payouts are typically lower than life-only option |
| Fixed Period (Period Certain) | Guaranteed payments for a set time
Remaining payments go to beneficiary if you die early |
As there is no lifetime guarantee, you run the risk of outliving the payment period |
| Life With Period Certain | Provides peace of mind with payouts for as long as you live
Your beneficiary receives payments if you die before the guaranteed period ends |
Typically, payouts are less than life-only policies due to the guaranteed period |
| Lump Sum | Grants you full access to annuity funds immediately | The entire sum is subject to taxes in the year received
You won’t have the annuity as an ongoing source of retirement income |
Factors To Consider When Choosing a Payout Option
Engaging in an annuity contract can be a savvy move to boost retirement income, but which payout option should you choose? That comes down to several factors.
The first question to ask is whether you want the annuity to provide for a beneficiary if you pass away early. If so, that may eliminate life-only as an option. However, if you want maximum payouts, life-only may be worth considering if you can stomach the risk of not leaving future payouts to your beneficiary.
From there, other factors include how long you expect to live, how much money you’d like to receive each payout, as well as the tax implications. Of course, no one knows how much time they have left to live, so this factor comes down to your risk tolerance. For example, if you want guaranteed payments for a certain period, a fixed period payout option may work best.
Consider how each option aligns with your financial situation and retirement goals.
What Are the Tax Implications of Each Annuity Payout Option?
Lump-sum payouts are taxed all at once and can push you into a higher tax bracket. With other options, a portion of each payment is taxed as ordinary income, depending on how the annuity was funded.
How Does Inflation Affect Annuity Payout Options?
Annuity payouts are typically fixed, so inflation can reduce their purchasing power over time. If you’re concerned about inflation, consider an inflation-protected or cost-of-living annuity.
Can Annuity Payout Options Be Changed Once Selected?
Typically, you won’t be able to change your annuity payout once you’ve made your decision and start receiving payments.
What Are the Payment Options for an Inherited Annuity?
If you inherit an annuity but are not the surviving spouse, you may have three options for payouts: you can take a lump-sum payout, take the full amount in installments paid over the next five years, or receive the annuity in regular installments over your lifetime.
The Bottom Line
Entering into an annuity contract with an insurance company can provide an additional source of income for retirement. Each annuity comes with options on how payouts are handled, and you’ll have to consider these carefully based on whether you want a death benefit, your expected life expectancy, desired payout size, and tax considerations. You may want to seek the guidance of a financial advisor to lay out what may be the best option for you.
