A lot of retirees use annuities to simplify their income stream in retirement but that doesn’t mean annuities are simple. Beyond choosing what kind of annuity to purchase – immediate vs. deferred and fixed, indexed or variable, you’ll also need to consider how to receive your annuity payments.
You can receive a lump sum from your annuity, a life option that pays over your lifetime and, if you choose, a spouse, other survivors or an estate, or a systematic stream of fixed payments that you receive annually, semi-annually, quarterly or monthly.
While the systematic withdrawal approach gives you the kind of reliable cash flow that you can coordinate with your monthly or other periodic expenses, the insurance company paying the annuity can’t promise that you won’t outlive your money. The other question involved is how often to take your payments, and whether there are any particular advantages to any one approach.
A financial advisor can help you choose an appropriate strategy for your annuity.
Whether you take your payments monthly, annually or on some other schedule, you’ll face the same tax liability. If the annuity was purchased with pre-tax dollars all of the payments are taxable no matter how often you receive them. For annuities purchased with after-tax dollars, only the portion of the payments that are gains are taxable, while the returned principal portion goes untaxed.
Either way, if you withdraw money from an annuity before age 59-1/2, you’re likely to face a 10% tax penalty. In exchange for this illiquidity, the tradeoff is that otherwise your annuity grows tax-deferred.
This is the most common, default option with many annuities, and allows a retiree to time the payments with their monthly bills. If you’re also collecting monthly Social Security or pension payments and taking cash out of an IRA or other retirement account, you might want to use that money to cover your monthly expenses and allow your annuity investments to grow a bit longer by taking an annual payment.
Talk to a financial advisor about the pros and cons of monthly, annual and lump sum payments.
With a once-per-year payment, the beneficiary can deposit the money in an interest-bearing account and take smaller quarterly or monthly withdrawals as they need cash, leaving the rest of the annual money to generate interest for more months to come. One safe way would be to deposit the annual payment in a high-interest money market account, which offers the safety of deposit insurance with the flexibility of writing a limited number of checks each month while leaving the remaining deposit to generate interest.
