Do I Have To Annuitize My Annuity Income?

Shawn Plummer

CEO, The Annuity Expert

The Definitive Guide To Retirement Income

There’s a lot of confusion about generating annuity income and which method of distribution is best, annuitize or guaranteed lifetime withdrawals? In this definitive guide to retirement income, we’ll go over the pros and cons of utilizing an income annuity and a deferred annuity with an optional income rider.

Figuring out how to distribute your long-earned retirement savings over a lifetime is a popular problem to tackle these days. But, unfortunately, there have been some wires crossed on how annuities, like pension income, generate a guaranteed lifetime income for retirees.

We’ll go over the key differences between the two methods so you can figure out whether to annuitize or not.

Income Riders

  • Flexibility to start/stop income stream
  • Potential to step-up the income amount
  • Costs range from no cost to 1.25% annually
  • Potential to earn interest
  • Future income guaranteed today
  • Can be surrendered
  • Lump-Sum Death Benefit
  • Help with long term care costs
  • Standard liquidity

Annuitization

Annuitize vs. Income Riders

Traditionally, income from annuities is either by annuitizing the contract or taking systematic withdrawals. The problem with both of these methods is the possibility of running out of money with systematic withdrawals and lack of flexibility with annuitization.

There is a HUGE difference between annuitizing your contract and generating lifetime withdrawals from an income rider (Guaranteed Lifetime Withdrawal Benefit).

Annuitization and the Guaranteed Lifetime Withdrawal Benefit accomplish similar tasks to distribute a guaranteed retirement paycheck from your annuity.

What does annuitize an annuity mean?

Annuitized distribution means converting your funds into an irrevocable income stream for a fixed period of time or a lifetime. Irrevocable means not possible to be changed, reversed, or recovered.

An annuity stream of cash flow payments is considered annuitization.

When an annuity is annuitized, the annuity owner is stuck with the income stream, and there’s no refund or cancellation. Pension Plans, deferred income annuities, immediate annuities, structured settlements, secondary market annuities, two-tiered annuities, and Lottery payouts annuitize its income distribution.

What if I don’t want to annuitize?

The Income Rider is an optional feature that distributes a percentage of your account value as a stream of retirement income for the remainder of your life. 

This stream can be turned on or off.  

Annuities with optional Income Riders

All annuities can be annuitized, including deferred annuity contracts. It’s a matter of whether the annuity owner has the option to annuitize or if the annuitization is mandatory.

The following types of annuities offer the ability to annuitize but are totally optional. As an alternative, an annuity owner can elect an income rider (Guaranteed Lifetime Withdrawal Benefit) instead to generate their lifetime income.

As mentioned earlier, annuitizing is mandatory for income annuities.

Death Benefit

A common misconception with annuities, in general, is that once the owner dies, the insurance company pockets the money leaving no death benefit to beneficiaries. However, this only happens in a few scenarios where a life-only-based payout is elected.

The death benefit varies on any annuitization payout. However, if there is a death benefit in most cases, the beneficiaries receive it over installments versus in a lump sum.

With an income rider, the death benefit is almost always in a lump sum. A surviving spouse can also exercise spousal continuance with an income rider too.

Interest-Earning Potential

During annuitization, one can expect to earn between 1 – 1.5% annually in interest. However, with an income rider, you earn whatever your base contract (traditional fixed, fixed index, or variable) earns, typically more than 1% annually.

Fees

There are no additional fees when an annuity is annuitized. However, annuity payments can be reduced due to payouts with guarantees, joint life payouts, lump-sum death benefits, cost of living adjustments, and commutation benefits. 

In most deferred annuities, additional fees will apply when electing an income rider.

Taxation 

Is annuity income taxable? Most annuities are subject to ordinary income tax except for the Roth IRA Annuity.

Exclusion Ratio

An exclusion ratio is expressed as a percentage and applied to each annuity payment to determine the portion of the payment that is excludable from taxable ordinary income.

After all the cost basis has been distributed, 100% of the annuity payments will be considered taxable ordinary income to the owner(s).

Annuitization Vs. Withdrawals

Lifetime withdrawals from an income rider and annuity payments from annuitizing your contract are 2 different methods of generating income from an annuity.

Last In, First Out (LIFO)

LIFO basically means any interest credited is applied to your annuity “Last,” and your original investment is applied to your annuity “First.” So with LIFO, your interest will come out first via withdrawals.

In a nutshell, you haven’t paid taxes on the interest you’ve earned thus far. So when you take income from your nonqualified annuity, the IRS wants the taxes paid on the interest first.

This means 100% of your retirement income (monthly, quarterly, semi-annual, or annual withdrawals) is 100% taxed until you’ve exhausted all of your gains from the annuity.

After you have exhausted all of your gains, your withdrawals are not taxable.

Conclusion

To annuitize or not is the question you have to ask yourself.

Annuitization typically pays a higher monthly amount to owners than annuity lifetime income, but you are cemented into the contract.

Income riders distribute a retirement income stream from your annuity that you can’t outlive, less than annuitizing in most cases, but more flexible.

Frequently Asked Questions

What does annuitize mean?

Annuitize is converting a lump sum of money into an irrevocable income stream of payments that can last for a specific period of time or life.

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Shawn Plummer

CEO, The Annuity Expert

I’ve sold annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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