If you’ve saved up a lot of money in an annuity, you’re in a fine position for a financially secure retirement. Once you are retired, what’s the best way to get your money out of your annuity?
All cash-value-type annuities, whether fixed-rate, fixed-indexed or variable, are tax-deferred until you take money out. If you’ve owned an annuity for many years, you probably have significant untaxed gain built up. It’s a good problem to have.
If you cash in and surrender your annuity, you’ll pay income tax on the gain all in one year, and that may bump you into a higher tax bracket. By taking out your money gradually, you can spread the taxation of that gain out over many years and avoid paying a higher tax rate — and also get a guaranteed lifetime income. That’s where annuitization comes in.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Securing a lifetime income
“Annuitizing” means converting the money in an existing deferred annuity into a guaranteed income stream. You turn over the money in the annuity to the issuing insurance company in exchange for guaranteed future income. This is commonly called an income annuity. Annuitization is irrevocable: You’ll no longer have access to your funds or the ability to withdraw them.
While you may choose an income annuity that pays out over a set term, such as 15 years, most people choose a lifetime income annuity. This option gives you a guaranteed monthly payout for as long as you live. Each payment includes both taxable income and nontaxable return of principal.
Even after the insurer has repaid the entire principal you deposited, you’ll still get the same income. A lifetime income annuity thus offers longevity insurance. It protects you from the financial risk of living to a very old age.
If you’re married, you can choose a joint-life payout so that a surviving spouse will continue to receive the same income after his or her spouse has died. Cash refund is also a popular option that guarantees that your premium payment will not be lost if you (or both spouses) die before the full amount of your annuity purchase has been paid back. If that happens, your named beneficiary will receive the difference.
Comparison shopping often beats annuitizing
Annuitization technically means you use the same insurance company that issued your existing annuity. That’s fine if your current insurer offers the best deal around.
But it probably doesn’t. The annuity industry is very competitive and constantly changing.
Before annuitizing, always get competitive annuity quotes to determine if other insurance companies will pay more income. Ask an annuity agent who represents multiple insurers to shop the market for you.
Here’s an example, with rates current as of mid-June 2021. A 70-year-old couple with a $250,000 annuity decides to convert it into a joint lifetime income annuity (meaning once one spouse dies, the payments continue throughout the lifetime of the other spouse). If they annuitize with their current insurer, they’ll get $1,123.43 a month for life. However, if they shop around, they can find another insurer that will pay $1,177.35 a month, and that’s $647.04 more each year.
Avoid unnecessary taxes and fees
If another insurer offers a better deal, your agent can arrange for a “1035 exchange” to the new insurance company. Such a transfer is tax-free, because the funds go directly from one annuity company to another.
The new insurer will use your money to set up a single-premium immediate income annuity — called an immediate annuity for short. Though this isn’t technically considered annuitization, it amounts to the same thing. The only difference is that you’re changing companies. You exchange your existing annuity’s accumulation value for a guaranteed income that starts immediately.
Unlike life insurance, annuities aren’t subject to underwriting. So, there’s just one potential roadblock to a 1035 exchange. Most annuities levy a surrender charge if you cash in the annuity during the surrender period. For example, a five-year fixed-rate annuity would usually have a declining surrender fee if you cancel the contract or remove more than the penalty-free amount of money before the five years are up.
To avoid paying that fee, you can wait until the surrender period is over to make your exchange. If you can’t wait, ask your annuity company if it will waive surrender charges when you annuitize with it. If it will do that, that’s great. But you won’t get the advantage of comparison shopping.
A free quote comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com or by calling 800-239-0356.
-
Six Missteps to Avoid as You Transition to RetirementDon't lose sight of your finances when you finally reach retirement. These six classic missteps can chip away at the nest egg you’ve worked so hard to build.
-
Why Does One Claim Jack Up My Insurance After Years of No Claims?Even loyal customers can be hit with an insurance premium hike after a claim, despite going many years without any claims. There's a reason for that.
-
To Future-Proof Retirement Security, We Need Better StrategiesWith retirees living longer and the inequalities that affect women and people of color, the retirement system needs some optimization. Here’s what would help.
-
Here's Why We All Win When Charitable Dollars Go to WomenGiving to charities for women and girls not only has a lasting impact on their lives — it also benefits society as a whole. Here’s how to start investing.
-
For a More Secure Retirement, Build in Some 'Safe Money'To solidify your retirement plan, write it down, reduce your market risk and allocate more safe money into your plan for income.
-
Five Steps to a Mindfully Fearless CareerIf, like many women, you're struggling with imposter syndrome, try developing an athlete's winning mindset. It's as simple as facing one small fear every day.
-
Six Ways to Optimize Your Charitable Giving Before Year-EndAs 2024 winds down, right now is the time to look at how you plan to handle your charitable giving. The sooner you start, the more tax-efficient you can be.
-
How Preferred Stocks Can Boost Your Retirement PortfolioHigher yields, priority on dividend payments and the potential for capital appreciation are just three reasons to consider investing in preferred stocks.
