Annuitization: Turning an Annuity Into Steady Income

What is annuitization?

Annuitization is the process of converting an annuity contract into a series of regular income payments. These payments can be set for a fixed period or continue for the annuitant’s lifetime. The arrangement shifts longevity risk from the annuitant to the insurer in exchange for predictable income.

Key points
* Payments begin under terms specified in the annuity contract.
* Payouts may be for a set number of years (period certain), for the annuitant’s life, or for joint lives (e.g., annuitant and spouse).
* Payment amounts are calculated using the annuitant’s age, life expectancy, and the insurer’s assumed interest rate.
* Options such as refund guarantees or period-certain clauses affect both beneficiary treatment and the payout level.

How annuity payouts are determined

Insurers calculate the payout rate when the contract is annuitized. Main factors:
* Age and life expectancy of the annuitant(s) — younger annuitants or longer joint lives lower periodic payments.
* Projected interest or crediting rate used by the insurer.
* Payout option chosen (single life, joint life, period certain, refund guarantees).

Because insurers assume the risk of someone living longer than expected, lifetime annuities can continue payments beyond the original payout-period calculation.

Common payout options

• Single-life annuity — Pays only while the annuitant is alive; payments stop at death and remaining balance typically stays with the insurer.
• Joint-life annuity — Continues payments until the second covered person dies; initial payments are lower to account for longer expected payout.
• Period certain — Guarantees payments for a minimum number of years; if the annuitant dies during that period, a beneficiary receives remaining payments.
• Refund options — Provide that a beneficiary receives any remaining balance or a minimum refund if the annuitant dies early; longer refund guarantees reduce the ongoing payout.

Regulatory and retirement-plan considerations

• Portability: Recent legislation has made certain retirement-plan annuities more portable, allowing some 401(k) annuities to be rolled into another employer plan or IRA when changing jobs.
• Fiduciary protection: Laws include safe-harbor provisions that can limit plan sponsor liability when selecting an annuity provider, encouraging availability within employer plans.
• Inherited IRAs: The SECURE Act removed the “stretch” distribution for most non-spouse beneficiaries; they generally must withdraw inherited IRA assets within 10 years, which affects annuity planning tied to inherited IRAs.

Eligibility and timing

• You can enter into an annuity contract at 18 or older; there is no upper age limit for annuitization.
• The decision to annuitize typically depends on retirement goals, need for guaranteed income, health, expected lifespan, and liquidity needs.

Pros and cons

Pros
* Provides predictable, steady income — useful for budgeting in retirement.
* Lifetime options hedge longevity risk.
* Certain annuity types can offer survivor protection for a spouse.

Cons
* Annuities can carry high fees and surrender charges, reducing net returns.
* Once annuitized, access to principal is usually limited or eliminated.
* Payouts are fixed by contract terms and may not keep pace with inflation unless an inflation rider is purchased (often at extra cost).
* Beneficiary benefits can be limited unless specific guarantees are purchased.

When annuitization may make sense

Consider annuitization if you prioritize guaranteed lifetime income, have limited other reliable income sources, and accept reduced liquidity and potentially higher fees. Compare annuity payout options, riders, and fees carefully and weigh alternatives such as systematic withdrawals from diversified investments.

Bottom line

Annuitization converts an accumulated annuity balance into stable, contractually defined income. It can be a valuable tool for securing lifetime income and managing longevity risk but requires careful evaluation of payout options, fees, beneficiary provisions, tax implications, and how it fits into an overall retirement plan.