Annuities

How Do I Organize My Money to Spend My Last Dollar the Day I Die? asked the investor
And the advisor said, “That’s no problem, Sir. What day will that be?”

Not knowing when we’ll die means making sure we arrange our finances to produce income for as long as we live. Aside from being able to live off just the earnings of our investments, only social security, pensions and annuities can pay you a lifetime income.  We would all like to have jut enough money to last until our last day and die broke.  While that seems like a wild idea, it’s doable.

Social Security gives you a lifetime income because the government can compel taxpayers to pay for it. And, if things get tight, they can print the money necessary to pay you.  And it stops the day you die.  If you do get a pension, it’s likely being paid by an insurance company in the form of an annuity.  As long as the insurance company remains solvent (large companies such as Prudential and New York LIfe lent money to the federal government during the Depression), you receive income for life that stops the day you die. If you like that idea, making optimal use of your money while your alive and then dying broke, you can also create your own private pension. 

Insurance companies – generally being more fiscally responsible than the government – use the voluntary premiums of thousands of annuity holders, the premium earnings, and the statistics of mortality to assure everyone a lifetime income. Using an annuity has some other advantages for you, too. Let’s look at a few.

The application advantage

Unlike life insurance, you generally don’t need a health exam to buy an annuity. Life expectancy for annuity payout purposes is determined by insurance company experience and not as a result of a physical examination.

The later payout advantage

Because of the nature of mortality rates, beginning your annuity payouts later mean your monthly payout increases for the same investment amount. So, the longer you can hold off receiving payments, means you need less investment money to achieve the same monthly payout.  If you have a joint and survivor annuity, two lives are used in the calculation and the amount of the payout is smaller than with a single life contract.

The tax advantage

During the accumulation phase of a deferred annuity, your investment grows faster because its earnings are tax-deferred. You pay income tax only during your annuitization (payout) phase – and then only on what hasn’t been taxed.  

If you purchased an immediate annuity – payouts start in about a month - with after tax money, only the earnings of your premium during the payout phase is taxed. This is a relative small fraction of each payout. If you’re able to outlive the mortality projection, you’ll receive a lot more money over and above your single premium payment.

If you purchase an annuity within your IRA, your payments must meet the Minimum Required Distribution (MRD) rules after you turn 70½. All of each payment is taxable income. The IRS has life expectancy- based table for determining the MRD amount. But with people living longer, this table is becoming dated. So the IRS will accept[1] a ‘lower’ MRD based on the insurance companies longer remaining life expectancy. 

To see if you can die broke and enjoy every last dime while your kicking, consult the immediate annuity calculator.

Note: Annuities once annuitized cannot be surrendered for value.  Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty.  Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses.

[1] www.irs.gov/publications/p590/ch01.html#d0e1252, Special rules apply if you receive distributions from your traditional IRA as an annuity purchased from an insurance company. See Regulations sections 1.401(a)(9)-6 and 54.4974-2. These regulations can be found in many libraries and IRS offices.

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What does it mean?

Put simply, to annuitize is to start taking payments from an insurance annuity that may have been accumulating for some time.  Specifically, you “trade” the accumulated annuity balance for a stream of payments over a specific term of years or life (a life annuity).

An annuity, a policy that is paid into either by lump some or regular payments by the policyholder, and gains value via investment of those funds by the insurance company that holds the policy, in a manner agreed between the two parties, has many terms attached when it is created, and there may be an option to annuitize at a certain point or date set at the start of the insurance annuity agreement.

What happens when I annuitize?

When, and how, the policy becomes annuitized is determined by the rules and terms that are agreed by the policyholder with the insurance company, and these can be varied and dependent on many different factors.

If the policy has a number of different options at which annuitization can take place, then it is up to the policyholder to decide what is best for him or her.  In many cases, if the insurance company does not hear from you, annuitization starts automatically at age 85.

When the choice is made, and one has opted to annuitize, there are a number of ways in which payments can be structured. There are options that involve continued payments within the lifetime of the policyholder, or those that pay up to a certain date (e.g. 10 years) beyond which the policyholder may live, but with no further payments. There are also options that allow a lump some payment of an agreed amount that can only be taken after a certain amount of time has elapsed on the policy, at which point the annuity is said to have matured.

Some annuities allow for the payments to be made to a partner or designated recipient (joint life annuitization), too, and there are other considerations that should be taken into account.

Should you Annuitize?

This is a question that only the policyholder can answer, but if the time has come to draw money from the annuity, some factors should be considered.

If the policyholder is collecting for himself, the lifetime payment option makes a great deal of sense, giving a guaranteed income for the rest of one’s life. The decision to annuitize, whichever option is taken, is not reversible – once done it cannot be rescinded, and the policy is deemed to have matured. (there are a few companies that now allow “commutation” which is the ability to cash in the annuity once it’s been annuitized.  You, the annuitant or owner will pay a stiff price to commute an annuity).

The most obvious reason for annuitizing is to claim the guaranteed payments that come with the policy, and this should be a consideration when deciding whether to annuitize. It may be that the policyholder needs the money in order to live, but in a large number of cases the money is used to set up a further annuity, continuing the process and effectively putting into action a chain reaction of annuities and annuitizing that creates greater income.

An annuity can be a worthwhile for those who like the option to annuitize and thereby shift the responsibility for income to the insurance company.

Learn more.  Get your copy to avoid “Annuity Owner Mistakes“

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