Annuities are insurance policies that guarantee you an income for your entire life or for a set period of time. Insurance companies provide you with two ways to take disbursements from your annuity contract. These disbursements each have their own benefits and drawbacks.
Although annuities are typically grouped with retirement fund accounts, there are few restrictions on annuities. IRAs have contribution limits and tax rules that are in place by the IRS that really constrict an individual from saving in large amounts for retirement. Annuities are not treated the same by the IRS, allowing individuals to save substantial amounts of money for retirement.
Read More: How Long do Annuities Last?
Annuity Disbursement and Guaranteed Payments
Annuities provide the option for guaranteed payments. In order to take advantage of this option, you must convert your savings to the guaranteed payment option. You may then choose to receive payments for your entire life or for a set number of years.
If you choose to receive payments for a set number of years, those payments will cease after the term is up. If you do not live out the term, your beneficiaries will receive the remainder of the funds. With lifetime payments, the payments stop at your death.
Read More: Types of Annuity Payouts
Withdrawals and How They Work
Withdrawals are made only from deferred annuities. A deferred annuity is an annuity that has not yet been converted to guaranteed payments.
Withdrawals may be made on a systematic or periodic basis. Systematic withdrawals are withdrawals made on a regular basis. Periodic withdrawals are withdrawals made when you need the money.
In both cases, withdrawals may only be made so long as there is money in the account. There is no guarantee as to how much money you will be able to withdraw from the annuity when using either the systematic or periodic withdrawals.
Benefit of Withdrawals
The benefit of withdrawals is that you retain control over your entire savings amount. If you need a lump sum of money, you can withdraw it and still make other withdrawals.
The benefit of guaranteed payments is that you'll never run out of money during the payment period. This may be especially important for lifetime payments because you don't know exactly how long you'll live. The guaranteed payments keep your income coming in until your death.
Disadvantage to Withdrawals
The disadvantage to withdrawals is that you are taxed as though you are removing all of your investment gain first. This increases your income tax when compared to guaranteed payments, since guaranteed payments from an annuity are treated as though the payment consists primarily of a return of your principal with a small amount of interest added to the payment.
The disadvantage to guaranteed payments, however, is that you lose total control over your savings amount. If you need a lump sum of cash, you won't have it, since your savings has been converted to monthly payments.
Read More: How to Convert an Annuity to a Lump Sum
I am a Registered Financial Consultant with 6 years experience in the financial services industry. I am trained in the financial planning process, with an emphasis in life insurance and annuity contracts. I have written for Demand Studios since 2009.