How to Convert an Annuity to a Lump Sum

How to Convert an Annuity to a Lump Sum
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When you plan for your retirement years, the single most important question is: How are you going to make your money last for your lifetime? Your answer to this question is key to your effort to survive beyond your official life expectancy age.

While both a pension and Social Security may last the lifetimes of many recipients, you may not receive these benefits or may want to supplement those monthly payments. An annuity is of benefit in either instance.

Even after you elect an annuity, you may decide a different type of investment is the right one for you. At that point, the questions become "What are my payout options?" and "How do I convert an annuity to a lump sum?"

Annuity Payout Options

The options for taking annuity payouts include the annuitization, systematic withdrawal schedule and lump-sum payment methods.

The Annuitization Method

The annuitization method guarantees that you'll receive monthly income for a specified period or for your lifetime. The method grants you control over the distribution schedule but it does not ensure that your annuity assets will last your lifetime.

The annuitization payout method option takes multiple forms:

  • Life Annuitization​. The life annuitization monthly payment provides its recipient a lifetime income stream, which addresses the risk an annuity's owner will outlive her income.
  • Joint Life Annuitization​. The joint life annuitization method recognizes two beneficiaries: the annuitant and the annuitant's spouse, the latter of which receives the payment upon the death of the annuitant.
  • Period Certain Annuitization​. Annuitization payments are distributed over a predetermined number of years, such as 15 or 20 years. Should the annuitant die before the elected payout period, the spouse receives the remaining payments.
  • Life with Guaranteed Term​. The life with guaranteed term method both provides an income stream for the annuitant's lifetime and makes payments to your estate should you die before the guaranteed term expires.

Systematic Withdrawal Schedule (SWS)

The systematic withdrawal schedule payout method allows you to determine, based on your contribution, the amount of cash you want to receive each month. You also choose the total number of payments that you will receive. In this case, you may well outlive the annuity's income stream.

The Lump Sum Payment Method

Should you elect the lump sum payment method, you will receive your annuity's payout value in a lump sum. A major disadvantage of this approach is that the annuitant pays tax on the account's capital gains in the year the lump sum is distributed.

Risks of Lump-Sum Payout Option

An annuity can provide a steady income stream after you retire. That's the reason most annuitants purchase the types of annuities that offer set monthly payments. The insurance companies do, however, allow a one-time payment to be made for the value of the annuity. It's commonly termed a lump-sum payout option.

If you choose a lump-sum payout instead of monthly payments – an act that must occur before payouts begin – the responsibility for managing the money shifts from your insurance company to you. In addition, you increase the risk of outliving your money or losing your money due to bad investment advice, fraud or poor stock market performance.

What's more, the Internal Revenue Service considers that lump sum payment to be ordinary income that's subject to income tax.

The decisions you make before you sign the annuity contract determine the amount of the payments that you, as an annuitant, will receive as well as the period during which you will receive those payments. Once you annuitize your contract, the conversion is irrevocable. This means you can't cancel the contract or get back your cash.

An annuity owner can, however, withdraw cash as a lump sum from a deferred annuity, rather than opting for an immediate annuity payout option.