Annuity Payout Options: How To Pick The Right One For You

An annuity is a financial product designed to provide a steady income stream, often during retirement. While an annuity can serve as a reliable paycheck replacement, the way your annuity pays out is just as important as the decision to purchase one.

The concept is simple: You hand over a single sum of money or series of payments to an insurance company, and in exchange, the insurer takes on the risk and promises a series of payments to you either now or years in the future.

However, the reality of annuities is complex and carries some risk. We’ll explore how annuity payouts are calculated and structured to help you make an informed decision.

How are annuity payouts calculated?

When it comes to calculating annuity payouts, there’s more to the story than just the type of annuity you choose and how long you’ll receive payments. Your age and gender are also key.

Insurance companies use actuarial tables to determine payouts, and life expectancy is their top consideration. If you’re older when payments start, your monthly checks will be higher because you have fewer years to live, so the insurer expects to pay out for a shorter time.

For example, a 70-year-old man starting payments will typically get a bigger check than a 60-year-old man choosing the same payout option.

While delaying your annuity payments can boost your monthly income, everyone’s situation is different, not unlike when you choose to claim Social Security. Waiting means you may need other income sources — like a part-time job, pension or retirement savings — to cover your expenses until those larger payments kick in. So really, the best time to buy an annuity depends on your unique situation and financial goals.

Another factor influencing your payouts is your gender. Women generally live longer than men, so their monthly payments tend to be lower compared to those of men of the same age.

The way you structure your annuity payments also plays a big role. Opting for a joint-life contract, which ensures payments continue to a spouse after your death, often means a smaller monthly payout compared to a single-life contract.

Finally, the size of your payout depends on the insurer and how they invest your money. If you go with a fixed payout, your monthly amount stays the same and the insurance company takes on all the investment risk. If you choose a variable annuity, your payouts will vary. Your check size fluctuates based on the market performance of underlying subaccounts, shifting more investment risk to you.

Annuity payout options

There are many ways an annuity can pay out. It largely depends on:

• When you want payments to start
• How long you want payments to last
• Whether you want payments for your life only or your life and your spouse’s life

Here are some of the most common annuity payout options and how they work.

Single life/life only

A single life annuity offers the highest monthly payout because the insurer only guarantees payments for your life — not your spouse’s. Payments are made for as long as you live. However, after your death, the payments stop, and no money is passed on to beneficiaries.

The payout amount is influenced by life expectancy: Shorter life expectancies result in larger payments, while longer life expectancies lower the monthly amount. If you live longer than expected, you may receive more than the total value of your annuity, which is beneficial if you expect a long retirement.

Also known as a “straight life” or “life-only” annuity, this option is ideal for people who are seeking maximum monthly income but don’t need to provide for a family member. However, it comes with a risk: If you pass away before receiving the full value of your annuity, the remaining balance stays with the insurance company.

To mitigate this risk, some people choose a life annuity with a period certain.

Life with period certain

A life-with-period-certain annuity combines the benefits of lifetime income with a guaranteed minimum payment period. While it’s similar to a straight life annuity, this option ensures payments continue for a set time — generally 10 to 20 years — even if you pass away during that time. If that happens, the remaining payments go to your beneficiary or estate.

For example, choosing a life annuity with a 10-year period certain means your annuity will pay you for life, but if you pass away after five years, your beneficiaries will receive payments for the remaining five years.

Because the insurer provides a guaranteed payment period, the monthly payment amount is lower compared to a straight life annuity.

This can be a good option for people who want guaranteed income for life but worry about dying early and leaving no financial benefit to their loved ones.

Joint and survivor

A joint and survivor annuity ensures payments continue for the lifetimes of both you and a second person, usually your spouse. When one of you passes away, the other will continue receiving income.

This results in smaller overall monthly payments compared to a single-life annuity because the payout needs to stretch in order to cover the life expectancy of two people instead of one. Some plans allow you to choose a reduced survivor benefit — for example, your spouse might receive 50 percent or 75 percent of the original payment instead of 100 percent — which might increase your initial monthly amount.

For added security, you can include a period certain option. This ensures that if both you and your spouse pass away before the guaranteed period ends, the remaining payments go to a designated beneficiary.

A joint and survivor annuity is a popular choice for couples who want to provide a level of financial stability for the surviving partner, regardless of who lives longer.

Lump-sum payment

A lump-sum payment lets you receive the full value of your annuity all at once. While this might sound appealing, it can carry significant tax implications. The IRS requires you to pay income tax on an annuity in the year you take the distribution, which could lead to a hefty tax bill.

And depending on the type of annuity you choose, you may face surrender charges and other penalties if you take a lump-sum payout or distribution.

Systematic withdrawal

A systematic withdrawal gives you control over the amount and frequency of payments from your annuity. You decide how much to withdraw each month and how often, but there’s a catch: Systematic withdrawal doesn’t guarantee your funds will last for the rest of your life.

Payments continue until either you stop them or your account runs out of money. So how long the payments last depends solely on the remaining cash value in your contract.

This approach shifts the risk of withdrawing funds to you. If you withdraw too much or live longer than expected, you could exhaust your funds before you need them most. While systematic withdrawals offer flexibility, they require careful planning to avoid financial shortfalls in retirement.

5 factors to consider when choosing an annuity payout option

Generally, you can’t change your annuity payout option once payments begin, so it’s important to evaluate your specific situation carefully before deciding. When comparing annuity payout options, consider these factors.

1. Life expectancy: Your life expectancy plays a major role in determining the most suitable payout option. For example, life-only annuities may be more beneficial if you expect to live well into your 80s or 90s.
2. Financial goals: Are you looking for lifetime income, flexibility or a legacy for beneficiaries? Your priorities will influence the best payout for you.
3. Tax implications: Understand the tax consequences of your chosen payout structure, especially with lump-sum payments and systematic withdrawals.
4. Beneficiary needs: If leaving money to your heirs is important, options like life with period certain or joint and survivor annuities may be appropriate.
5. Financial planning: Consulting with a financial advisor can help ensure the annuity you choose fits in with your broader retirement strategy. An advisor can also help you consider all the potential risks of owning an annuity.

You might consider buying an annuity if:

• You want steady income in retirement.
• You are concerned about outliving your savings.
• You are a conservative investor who prefers stability to growth.
• You have a long retirement horizon.
• You don’t need immediate access to your money.

An annuity might not be right if:

• You already have enough guaranteed income from other sources.
• You have a shorter life expectancy.
• You want high growth potential for your investment.
• You are uncomfortable with the fees and complexity that accompany annuities.
• You need quick access to your funds.

Bottom line

An annuity can be a strategic tool in retirement planning, but selecting the right payout option is important. Each comes with its own potential benefits and trade-offs, so understanding how these payouts align with your financial goals, risk tolerance and lifestyle is essential. By evaluating your priorities and seeking professional advice, you can maximize the usefulness of your annuity long into retirement.

— Kim Husband contributed to an update.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.