How Do Annuities Pay Out?

How Do Annuities Pay Out?

annuity savings

Once you reach the second part of your annuity, called the distribution phase, new questions will arise. Annuitants want to know how and when annuities will pay them and what percentage, if any, will go to taxes while they are saving and inevitably withdrawing. Luckily, the options and variables involved in these concerns are straightforward and can make the second stage of your annuity tailored to your personal needs.

How Annuities Pay Out

There are a few ways that annuities can pay out, depending on the annuity holder’s personal needs and decisions. Whether you have an ongoing income or decide to withdraw on your own, you can decide how much and how often you can receive money after the surrender period is finished.

You may want to withdraw money once you have reached the required age. Withdrawing has a few options for you to choose from, depending on how soon you need your investment in your pockets. You can withdrawal all money in the annuity at once in a lump sum. You can also withdraw it on your own over a period of time and take out the same amount each time or take out the amount you need as you go. This gives you an ongoing control over your money and allows you to choose how much you receive. But, with this option, there is no guarantee on the longevity of your annuity and it may not last you throughout your retirement.

Your other group of options falls under the guaranteed income blanket. A guaranteed income annuitizes your savings to create an ongoing stream of payments, paid out at a rate that you and your annuity issuer will work out. This payment could be monthly, quarterly, yearly, etc.

This amount can either be a fixed amount agreed to in your contract or it can be variable and depend on the market value of the annuity. You can elect to receive payments for the remainder of your life or you can choose to receive payments for a specific period of time. You can also choose to have a lifetime payment include your own lifespan and the lifespan of your partner, called a joint and survivor annuity”, that allows you to provide security for your spouse. How much you receive per payment will be based on how much money has been saved, when you start withdrawing and how your earnings are credited to the account.

Are Annuities Tax Free?

An annuity does have taxes, but the manner in which it is taxed allows the annuitant to stave off their effect for as long as the account is untouched. Taxes on an annuity are deferred for as long as the account is surrendered and only go into effect when pay outs commence. This means the percentage of your earnings are uneffected while you save.

The taxation on an annuity is affected by several factors. One is whether the annuity is an immediate or deferred payout. An immediate payout bought with after-tax money only applies taxes to your gain and not to your initial investment. If you have a deferred annuity, the rule above applies and no taxes apply to the annuity, no matter if it is a fixed or variable annuity. Even if you move money between accounts or mutual funs, the taxes will remain deferred so long as you do not withdraw from your annuity.

If you want to avoid taxation on your total earnings, it is best to purchase your annuity with after-tax money. If you purchase it with pretax money, the whole annuity will be subject to taxes when withdrawing begins. If you withdraw a lump sum from your deferred annuity, you will be taxed on all earnings and interest higher than the initial investment. Smaller withdraws will be taxed until you hit the point where only the initial investment remains. When you reach the initial investment, your withdraws will be tax-free.

Consequences of Cashing Annuities Too Early

It is best to be wary of withdrawing money from an annuity too early unless you qualify as an exception. If you withdraw money from your annuity before you reach 59 1/2  years old, the IRS will penalize you with a 10% tax on your withdraw in addition to the taxes already applied to your withdraw.

If you end up in a situation where you need to do a full cash withdraw, it is advised to make a full surrender. This will allow you to cash out the annuity early and cancel your contract. But the price of this is high, as there will be a surrender penalty and taxes that will be owed to the IRS. On top of this, if you surrender before the age of 59 1/2, the 10% additional penalty tax will still apply to the money you cash out. This can add up to costing you a pretty penny on your overall earnings.

There are some annuities that offer partial surrenders that allow you to maintain your contract while still withdrawing from the annuity early. With this, often times, you will still receive a surrender penalty but the company could lower or waive its surrender penalty. With a partial surrender, you could still owe taxes to the IRS on top of the 10% penalty that comes with an early withdraw.

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