One of the biggest risks in retirement is running out of money. You can't predict exactly how much you'll need or how investments will perform, so it's impossible to know how long your resources will last. But annuitization offers a unique way to manage your risk and create income for life.
What Is Annuitization?
When you annuitize, you use an annuity to convert a lump sum of assets into a stream of income. An insurance company provides income payments, and you no longer need to manage the assets you annuitize.
For example, you might have money saved for retirement. If you want that money to provide guaranteed income, you could shift some of that money to an annuity contract and annuitize.
Annuitization is typically an irrevocable decision. Once you annuitize, the lump sum is no longer available to you for on-demand withdrawals, and you generally can't change your mind. Because of that, it's critical to convert only as much as you need.
You can often customize how you receive income from an annuity.
The simplest option is a single-life payout. With that approach, the insurer pays you for as long as you live, regardless of how long you live. After your death, the payments stop.
This option typically provides the biggest payments because the insurer keeps the funds you add to an annuity — even if you die shortly after starting payments. On the other hand, if you live longer than expected, the insurer needs to continue payments, potentially returning substantially more than you paid in.
You can also arrange payments that last for your life and a spouse's life. That way, the insurer continues paying for as long as one of you is still alive. Those payments might remain the same for both lives, or you might choose a reduced payment after the first death (this usually allows for a higher payout upfront).
Because the insurer is obligated to pay for two lifetimes, payments will likely last longer than they would with a single life. As a result, the payments for a joint payout are typically smaller than they would be for a single-life annuity.
If you want to ensure that payments continue for a minimum number of years, you can use a period certain. For example, a 15-year period certain contract will pay out for at least 15 years.
When you combine a period certain with a lifetime payment option, payments continue for the longer of your life or the period certain, potentially helping with concerns about dying shortly after payments start. For example, if you die after two years and you have a 15-year period certain, your beneficiaries would receive payments for the remaining 13 years. In this example, if it's a lifetime payout with a period certain and you live longer than 15 years after annuitizing, those payments continue for life.
You can also add a refund option if you're concerned about dying before getting sufficient value out of an annuity. With that option, your beneficiaries might receive a lump sum or payments that equal the initial premium you paid into a contract.
Remember that any features that reduce your risk may also lead to smaller monthly payments. This allows both you and the insurer to accept some risk. However, the income reduction might be surprisingly small, so ask an agent to share specific numbers with you.
The Bottom Line
Annuitization is a powerful way to arrange for income, enabling you to set yourself up for a higher monthly income than you can get from other sources. But annuitizing is irrevocable, and there's always the risk of dying shortly after you annuitize. Fortunately, you have several options for payouts, and you might find ways to address the risk of an early death.
If lifetime income sounds appealing, explore how you might set up payments. If you have existing annuities, you may be able to convert those contracts to a stream of income (with or without annuitizing, although annuitization generally offers the biggest payments). If you don't currently have any annuities, you can start a contract and convert the funds to income whenever the time is right.