What Is Annuitization?
Annuitization is generally considered to be a retirement planning strategy where your money from an IRA or 401(k) plan is converted into guaranteed monthly payments. This will ensure that you have a stable and reliable income throughout your life so you can maintain a comfortable standard of living. Annuities are insurance contracts that are created with the help of life insurance companies. When you choose to annuitize, your money is placed into an annuity “inevitably” meaning you cannot access it until the end of the contract. To find out how much monthly income you will receive from your annuity, there are three major factors that will be taken into consideration:
- The amount of money you have in your annuity, which will determine the size of monthly payments
- Your life expectancy, which will determine how long you live and how much time your annuities can generate a return for YOU.
- What kind of interest rate the annuity contract has, which will determine how much can be generated by your account.
Though annuities are an effective strategy to take care of yourself in retirement, they come with benefits and drawbacks that may impact you later on.
How Does Annuitization Work?
Annuitization is the process of taking your retirement account funds and turning them into some sort of guaranteed income for you. You can go about this in two ways: annuitizing an IRA or 401(k) plan, or opting to receive a lump sum payout from it instead. If you choose the first option, you will receive a monthly income throughout your life. What’s great about this is that you will never run out of money because it will continuously payout to you. What’s bad about this, however, is that the amount of money that you will get from your annuity can be affected by external factors such as interest rates and returns on investments. Conversely, if you choose the second option and get a lump sum payout from your IRA or 401(k) plan, you will receive a one-time payment that depends on how much money is in your account. What’s great about this is that whatever amount of money you get from it can’t be affected by external factors such as interest rates or returns on investments. What’s bad about this, however, is that your reduced income may not be enough to support you. Financial experts typically discourage retirees from opting for a lump sum payout because there are too many things that you cannot control with it. Your money will only last as long as your life expectancy and how well the market performs.
Who Should Consider an Annuity?
Since annuities are insurance contracts, they are effective tools to use for retirement planning because they provide the security that you need in order to maintain your standard of living throughout your lifetime. Annuities will only work for certain people because there are specific traits that have to be met for them to become effective. You have to be willing to not touch the money in your account for a long time, and you have to be willing to accept the uncertainty of your monthly income. This is an advantage since if you do meet these requirements, annuities can provide a steady and reliable source of income throughout your lifetime. On the flip side, there are some people who will not be able to handle the amount of time that money is locked up for, and there are others who would rather invest the money themselves so they can have more control over it.
Benefits and Drawbacks of Annuities
As mentioned earlier, annuities provide security to retirees because your income will not be affected by how well the market performs or external factors such as interest rates. The benefit of this is that your retirement income will be guaranteed for as long as you live. The drawback, however, is the uncertainty of how much money you will receive monthly depending on how much money is in your annuity account. It also does not provide any extra benefits to retirees such as social security or Medicare coverage. These are features that you will have to look out for in the annuity contract, and if not included in it, you may have to find an additional contract.
The Bottom Line
Though annuities are an effective strategy to take care of yourself in retirement, they come with benefits and drawbacks that may impact you later on. While it is a good option for some retirees because of the guarantee that comes with it, other retirees find that opting for a lump sum payout will be more advantageous because there are too many uncertainties in an annuity contract. Though it is advisable to consult with a financial adviser in order to make the right decision, an annuity is one effective strategy that you can use to secure and maintain your standard of living and retirement needs.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.