What Is Annuitization?
Turning an investment in an annuity into a series of recurring income payments is known as annuitization. Annuitizing annuities can be done for a set amount of time or the whole life of the annuitant. Only the annuitant or the annuitant and a surviving spouse in a joint life arrangement are eligible for annuity payments. Annuitants can designate who will get a portion of their remaining annuity amount after passing.
Although annuitization has been around for centuries, it wasn’t until the 1800s that life insurance firms codified it into a contract made available to the public.
The commitment to provide regular payments for a predetermined amount of time or the remainder of the annuitant’s life can be exchanged for a large sum of cash through a contract that individuals can engage in with a life insurance firm.
How Annuities Are Calculated
The life insurance does computations to estimate the annuity payout amount after receiving the lump sum of capital. The main variables utilized in the computation are the annuitant’s present age, life expectancy, and the anticipated interest rate the insurer will apply to the annuity amount. The resultant payout rate determines the income the insurance will pay such that after the payment period, the insurer will have paid the annuitant’s whole sum plus interest.
The payout period might be a predetermined time frame or the investor’s life expectancy. If the insurer finds that the investor has a 25-year life expectancy, that time frame will be used for payments. If the annuitant lives longer than expected, the life insurer must continue the payments until the annuitant’s death. This is a key distinction between utilizing a set and lifetime periods. The life insurer takes the risk of a prolonged lifespan in this annuity’s insurance component.
Assurance Payments based on an Individual Life
When an annuitant dies, the payments on a single-life annuity stop and the insurer keeps the remaining principal. When payments are based on combined lifetimes, they keep on until the second annuitant passes away. When an insurer insures joint lives, the annuity payment is decreased to account for the second life’s increased longevity risk.
Through a refund option, annuitants can choose a beneficiary to receive the remaining amount of their annuity. Refund options are available to annuitants for various time frames during which, in the event of death, the beneficiary will receive the money. For instance, the insurer will not pay the beneficiary the refund if the annuitant dies after choosing a refund option for a term specified as ten years. The duration of the return term will impact the payment rate, even if an annuitant might choose the lifetime refund option. The payment rate decreases with the length of the refund term.
Annuities in Retirement Accounts Undergoing Changes
The SECURE Act, enacted by the US Congress in 2019, introduced reforms to retirement plans, particularly those involving annuities. The good news is that annuities are now more transferable according to the new rule. For instance, if you switch jobs, you can transfer your previous job’s 401(k) annuity to the new job’s 401(k) plan.
However, the SECURE Act reduced some of the legal hazards for retirement programs. The decision restricts account holders’ ability to take the retirement plan to court if it fails to make annuity payments, as may happen in a bankruptcy. The SECURE Act’s safe harbor clause shields retirement plans against lawsuits but not annuity providers.
The SECURE Act likewise removed the stretch provision for IRA beneficiaries. A beneficiary of an IRA used to be able to spread out the required minimum distributions from the account throughout their lifetime, which reduced the tax liability. The new rule mandates that non-spousal beneficiaries release the entirety of the inherited IRA’s money within ten years of the owner’s passing. The new legislation does have certain exceptions, though. This article does not attempt to analyze the SECURE Act thoroughly. The proposed modifications to retirement accounts, annuities, and their specified beneficiaries should thus be reviewed by investors in consultation with a financial expert.
- Turning an investment in an annuity into a series of recurring income payments is known as annuitization.
- Annuitizing annuities can be done for a set amount of time or the whole life of the annuitant.
- Only the annuitant or the annuitant and a surviving spouse in a joint life arrangement are eligible for annuity payments.
- Annuitants can designate who will get a portion of their remaining annuity amount after passing.