If using annuity payments to provide lifetime income is the strategy that seems to make the most sense, you can select a payout plan that suits your individual situation. All nonqualified annuity contracts offer some tax-free income until the total amount of your premium has been repaid. All but two of them promise income for life, based on the claims-paying ability of the company issuing the contract.
INFLUENCING FACTORS
There are several key factors to consider when you weigh the various payout options. It makes sense to review them with your financial adviser before making up your mind.
1. The first decision is how the income will be paid.
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Should the payout be joint and survivor?
For many people, wanting to provide lifelong income for a spouse or other survivor is the driving force in choosing a joint and survivor payout. Each individual payment amount is less than with a single life annuity, but the total over two lifetimes can be more, sometimes much more. For many people, providing for a surviving spouse or partner is a primary concern of long-term planning. -
When isn’t a joint and survivor policy the wiser decision?
Among the factors to consider are how much income each of you has from other sources and how healthy you are. For example, if you own an annuity and your spouse has a good defined benefit pension, taking a single life annuity might make sense. It would provide more income than a joint and survivor payout, and your spouse is already guaranteed lifetime income. Similarly, if your spouse is ill, and unlikely to outlive you, a single life annuity might be the wiser choice.
2. The second decision is choosing the percentage of income the survivor will receive.
The follow-up decision is what percentage of the income that you receive while you’re both alive should be paid to the surviving person. There are usually several choices, with the least being 50% and the most 100%.
The decision involves trade-offs, as so many things do. If the surviving partner gets 100% of the income, the amount you get while you are both alive will be less. But the goal in choosing that alternative is that the survivor will have as much income as he or she needs.
On the other hand, a variable annuity paying the survivor 50% may provide sufficient income, since the living expenses of one person could be less than for two. Additionally, the variable annuity paying the survivor 50% can potentially provide enough growth to make up the difference over time if the investment portfolios you’ve chosen produce strong returns. Of course, there is also the possibility that the survivor’s payments will decrease if the investment portfolios you’ve chosen don’t produce strong returns.
3. The third decision is the term over which the income will be paid.
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Should you choose a life annuity that guarantees a certain number of payments?
One reason people give for choosing not to annuitize is that they’re afraid if they die shortly after they begin receiving payments, they will forfeit a large portion of the amount they spent to purchase the annuity. To avoid that situation, some people choose a period certain payout guaranteeing that they or their beneficiaries will receive income for at least a minimum period, typically 5, 10, or 20 years.You can choose a period certain payout whether you take a single life or joint and survivor option. Although the guarantee reduces the amount you get somewhat, it’s often a smart choice.
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Should you take a payout that doesn’t guarantee life income?
If the reason you’re annuitizing is to be able to count on income for as long as you live, you should choose the lifetime guarantee. But there are situations when getting a larger amount of money each month or insuring payments will last a specific amount of time is a smart decision.What’s appealing is that these payout models may produce larger income payments in the short term. Also, when you select this option, you typically have the opportunity to commute, or cash in, your annuity for a lump sum during the term rather than receive income payments in the future.
In addition, in these plans part of your income payment is always tax free. With lifetime payouts, you may end up owing tax on the entire income amount of each payout if you live long enough to get your entire cost basis back. Of course, this is not really a negative since it means that you’re getting back more than you put in.
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What if you want to receive income payments while you continue to build your retirement assets?
A split-funded annuity lets you begin receiving income from a portion of your principal immediately, while the rest of the money goes into a deferred annuity. The advantage is that you can get some income right away, while the balance compounds tax deferred. The goal is a larger income in the future when you begin to draw on the deferred portion as well.
THE FIXED ALTERNATIVE
There are circumstances when knowing exactly what you can count on each month may seem more appealing than the potential for growth. And there’s a way to arrange that as well.
You can receive fixed income from your variable annuity by tapping either part or all of the accumulated value of your contract. The way it works is that the assets in your investment accounts are liquidated and deposited into the annuity provider’s general account. The company then takes the responsibility for making regular income payments, subject to its claims-paying ability.
With some contracts, you may also be able to choose a fixed payout that increases in increments of 1%, 2%, or 3%, reflecting increases in the cost of living. There will probably be an additional fee for that option.