What Is the Difference Between an Annuity & an Installment Payment From a Qualified Plan?

What Is the Difference Between an Annuity & an Installment Payment From a Qualified Plan?
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Annuities are one of the most popular types of retirement investment vehicles, mostly because of the additional benefits provided by the insurance companies who issue these products. When it comes time to begin taking distributions from your annuity account, you will have several options, some of which may have significantly different results.

What's a Qualified Plan?

Qualified plans must meet the requirements of the Employee Retirement Income Security Act (ERISA) which was enacted in ​1974​ to protect individual retirement income. ERISA sets minimum federal standards for voluntary retirement and health plans that are made available to employees from private employers. Employers select the type and details of a qualified plan as allowed and mandated by law.

The IRS defines a qualified annuity as an annuity that is purchased for an employee by an employer under a qualified plan. If your annuity is designated an IRA, ​401(k)​ or similar tax-advantaged account, it is considered “qualified.” The IRS has strict guidelines regarding the "form and operation" of qualified retirement plans. Money in qualified retirement accounts has been deposited without first being taxed. The entire sum will eventually be taxed, but only those portions actually withdrawn will result in tax liability for that year.

Qualified plans are either defined contribution plans or defined benefits plans. Defined contribution plans mean that the amount of contribution is set by the employer, such as in the case of a profit-sharing plan like a ​401(k)​. The benefits of a contribution plan will depend on actual contributions and associated earnings. A defined benefits plan will focus on the benefits, such as a specific percentage of an employee's highest salaries over a specific number of years.

How Much Control Do You Need Over Payments?

If you arrange a series of regular installment payments or withdrawals from your annuity, you will get a check for your chosen amount at regular intervals. You will have the ability, however, to stop or pause those withdrawals at any time for any reason, as well as to resume them. However, if you elect to annuitize your account, those payments are fixed and cannot usually be stopped. Annuitization is the process of permanently converting your account value to a fixed stream of payments; and once chosen, this cannot be undone.

In addition to being stopped and restarted at will, the size of your installment payments can also be adjusted to suit your changing financial needs. Annuitization, on the other hand, creates a pre-determined stream of income that cannot be manipulated, changed or increased beyond the provisions in place at the time the arrangement was made.

Because installment payment selections can be changed at any time, you retain access to and control over the remaining balance in your annuity account. If you need a larger sum of money than what you received as an installment payment, you can easily withdraw more money. However, in an annuitized contract, any remaining lump sum in your account is forfeited to the insurance company in exchange for the guaranteed payment arrangements.

What Happens If You Outlive the Money?

Perhaps the most significant advantage to annuitizing your contract is the ability to create a guaranteed income stream that will last forever. All annuities share this characteristic and offer the option of receiving money every month for the remainder of your life, regardless of the performance of the financial markets, political climate or current events. Non-annuitized accounts, on the other hand, can be arranged to send regular monthly distributions but cannot guarantee that income will last forever.

Any money remaining in the account is subject to the terms of the specific annuity type, which could expose the balance to volatile stock market and financial conditions. Current events that negatively impact the insurance carrier’s ability to positively invest annuity funds would result in decreased interest rates or even decreased account values for owners of variable annuities.