Annuity payout options — and how to choose

Whether you're wondering how to turn your retirement savings into regular income after you stop working — or seeking to create a stream of guaranteed income payments before then — annuities may be uniquely suited to the task. However, annuities — and their payments — come in many forms, and can be harder to understand than other savings and investment vehicles. We’ll try to clarify things a bit by explaining:

• Annuity basics

• The difference between "income” (immediate) and “deferred” annuities

• The differences between fixed, variable, and indexed annuities

• How various types of annuities pay out benefits

• Which of the various payout options may be best for you

What is an annuity?

Annuities can provide financial stability and assurance for retirees looking to secure steady income in the future. Before getting to the question of how annuities pay out, it's a good idea to review a few basics. An annuity is a financial product offered by insurance companies and financial institutions that provides a regular stream of guaranteed payments in return for your investment.¹ Annuities are actually binding contracts to make payments for either a predetermined number of years, or for the rest of your life.

The annuity owner is the person or entity that buys and controls the contract (which includes choosing payout options); the annuitant is the person whose life expectance the payout is based on and who usually receives the income. They are often the same person or entity, but they do not have to be. For example, a family trust could purchase and own an annuity, and the annuitant could be a family member in the trust.

Annuities are especially popular with retirees, because they can provide predictable payments in retirement — and because they also support long-term financial well-being by protecting against the risk of outliving your savings. Annuities can also be a tax-advantaged retirement savings vehicle with fewer contribution and withdrawal limits than IRAs. Payments are guaranteed by the insurance company, so they can provide the financial stability and assurance many seek in their retirement years.

What are the different types of annuities?

The basic types of annuities are “immediate” and “deferred.” The difference has to do with when you start getting your payout.

• Immediate income annuities can start making regular payments almost immediately — within one year of your initial investment, which is typically made with a single lump-sum premium payment. (These are often called an SPIA, or single premium immediate annuity, because they are typically purchased with a single premium, or one lump sum, for the purpose of providing immediate income.) This type of annuity is a good fit for people who have already built up a retirement nest egg, and are at the point where they want to start generating income from their savings.

• Deferred income annuities can be funded with a single or recurring premium payments, and should be used for income needs that are several years away. So they can be a good fit for people who don’t need income from their investment in the next few years, but want to secure future retirement income. It’s important to note that owners of deferred income annuities typically lose access to their funds until age 59 ½.

Annuities can also be categorized by how your funds grow until they’re paid out to you. So, an annuity can also be “fixed,” “variable,” or “indexed”:

• Fixed annuities offer a guaranteed rate of interest for the term of the annuity. With a fixed annuity, you’ll know in advance how much your money will earn over time. It’s best for people seeking predictable returns during the accumulation phase.

• Variable annuities offer access to a range of market-based investment funds such as stocks, bonds, and money markets. Variable annuities have the potential to generate better returns and more income than fixed annuities — but importantly, there are no guarantees and your contract value could decline due to poor market performance. There is a risk that if your selected investments don’t perform well, a variable annuity may return less income than a fixed annuity. That’s why people should consider their risk tolerance and investment objectives when choosing this type of annuity. It’s also important to note that variable annuities tend to have higher fees, commissions, and surrender charges than fixed annuities.

• Indexed annuities (also called fixed index annuities) are a sort of “hybrid” of fixed and variable annuities. They offer a guaranteed “floor” or minimum rate of interest like a fixed annuity, but are also tied to a market index — which gives them the potential for additional returns. The drawbacks? There’s generally a cap on how much you can earn in a given year; for example, your chosen index could go up by 15%, but if your cap is 12% that’s all you’ll earn. Also, indexed products tend to have higher fees, commissions, and surrender charges than fixed annuities, so make sure you’re aware of all the potential costs before investing.

Ultimately, the choice between a fixed annuity, variable annuity, or indexed annuity comes down to your individual objectives and desire for a given level of financial returns at an acceptable risk. These are issues to discuss with your financial advisor before making a decision to invest in an annuity — or any other investment product.

What are the different annuity payout or income options?

One of the biggest decisions you’ll have with your annuity — if or when you decide to convert these savings to income — has to do with choosing a “payout option”. In other words, how you’ll receive your annuity income once the payout period begins. Most annuities offer multiple options, but not all annuities offer every option listed below. So it’s essential that you understand the different options that will be available with the specific annuity that you purchase. Those options may include:

1. Life Only: This provides recurring guaranteed income payments that continue until the annuitant passes away, regardless of how long that may be. So this option offers dependable income for as long as they are alive in retirement.

   • One key benefit: The Life Only option may provide higher overall payouts than other payout options.

   • One key drawback: Unlike some other annuity options, Life Only does not provide any death benefit or payments to beneficiaries after the annuitant's death.

2. Joint and Survivor: Here the annuitant and joint annuitant receive periodic payments for as long as they are alive and — after the passing of one annuitant — their spouse or partner will receive payments for as long as they are alive.

   • One key benefit: The surviving spouse or partner is protected financially after the annuitant’s death.

   • One key drawback: Payments may be lower than other payout options since the insurance company will have to continue payments for a longer time.

3. Life with Period Certain: This option provides an annuitant with regular payments for as long as they are alive, and payments continue to their beneficiary for a selected period if the annuitant passes during that period.
   For example: If the annuitant selects a life with ten years period certain payout option, and passes after six years, their beneficiary will receive the annuity payments for the four remaining “period certain” years.

   • One key benefit: The surviving beneficiary may receive annuity payments after the death of the annuitant.

   • One key drawback: Annuity payments may be lower than other payout options, because the insurance company may have to continue payments after the annuitant dies.

4. Period Certain Only: This may also be called a “guaranteed period” or “certain only” annuity. In any case, this option guarantees payments for a specified period specified period of time, regardless of how long the annuitant lives. If they pass away during that time, their beneficiary will continue to receive the payments for the remainder of the specified period (also known as guaranteed term).
   For example: The annuitant wishes to receive payments for 20 years. If she passes away after 15 years, payments will go to her beneficiary for the remaining five years.

   • One key benefit: Payments may be higher than other payout options because they are only made for the specified period — the insurance company doesn’t have to guarantee payments for an open-ended period of time.

   • One key drawback: The annuitant may outlive their income: if he or she survives beyond the fixed period, annuity payments stop.

Additional income options

1. Systematic Withdrawals: Also known as “fixed amount,” this option allows the owner to specify the amount and frequency of their withdrawals which then last until funds in the annuity run out.

   • One key benefit: Can give the owner more control over their finances.

   • One key drawback: They may outlive their withdrawal income.

2. Lump Sum Payment: This option allows the owner to receive the entire principal of the annuity at one time, instead of regular payments.

   • One key benefit: The owner has immediate access to all their funds.

   • One key drawback: The owner could have to pay significant income taxes on the taxable amount of their withdrawal. Generally speaking, in a qualified annuity purchased with pre-tax dollars, the entire sum would be taxed as ordinary income; in a non-qualified annuity bought with after-tax dollars, only investment earnings are taxed.

3. Early Withdrawal: While this option is rarely recommended, in certain circumstances the owner may be able to withdraw all or part of their annuity principal before the beginning of the payout phase specified in their annuity contract. Also, withdrawals before age 59 ½ from a qualified annuity may trigger income tax and additional government penalties.

   • One key benefit: Owner can access funds at a time of need.

   • One key drawback: There may be significant fees, financial penalties, and tax consequences.

When considering the tax consequences of any type of annuity withdrawal or distribution, it is important to understand that you may owe ordinary income taxes on the taxable amounts, which could include the entire payment or only the investment earnings portion, depending on whether it is a qualified or non-qualified annuity. Before making large withdrawals or choosing a payout option, consult a tax advisor or tax professional to understand the income tax and ordinary income tax implications for your specific situation.

Need help deciding which option is right for you?

Annuities can provide a guaranteed income stream which can make them a valuable part of your retirement planning. However, annuity contracts are often more complicated and difficult to understand than other savings and investment products. Are annuities a good investment for you? It’s a good idea to consult a trusted financial advisor prior to making any purchase decisions. If you don’t know such a person, Guardian can help. A Guardian financial advisor will listen to your needs, help you define your goals, and work with you to make the right decisions. And if you decide an annuity is right for your needs, they’ll help guide you through the purchase process. Here’s how to find someone near you: