What Happens When You Annuitize an Annuity?

by Tim Plaehn ; Updated July 27, 2017

A deferred annuity is a retirement savings vehicle with an insurance company that earns tax-deferred interest until the money is needed to provide retirement income. To annuitize a deferred annuity is to convert the lump sum value of the annuity into an income stream. The Bankrate website calls annuitizing a do-it-yourself pension.

Annuity Terms

Annuities are retirement products sold by life insurance companies. A deferred annuity is a lump sum of money that earns tax-deferred interest until it is time to convert the money to a retirement income. An immediate annuity is a lump sum of money, from which the insurance company pays a guaranteed, fixed monthly income. The annuity converts the lump sum into monthly payments that can be considered a return of principal plus interest. Converting a deferred annuity to an immediate annuity is called annuitizing the contract. The person receiving the annuity payments is called the annuitant.

Annuity Income Options

The basic annuity choices when annuitizing are a lifetime income or a monthly income for a fixed period of years. The fixed period is called period certain, and the insurance company will make the monthly payments to the annuitant or a beneficiary until the full term is complete. Typical terms are 10, 15 or 20 years. A lifetime annuity guarantees a monthly payment until the annuitant dies. The payment may be for just a month if the annuitant dies then, or it could last for 40 years or more. The payments stop when the annuitant dies, not before.

Annuity Income Modifications

The lifetime annuity payout can be modified with a period certain, joint-and-survivor, or refund modification. Adding a period certain means the payments will continue throughout the life of the annuitant or a fixed period of years, such as 10 years, whichever period is longer. A joint-and-survivor annuity will make monthly payments based on the lives of the annuitant and a beneficiary. Payments will continue until both are deceased. A refund annuity guarantees the payment total will be at least the amount of the original lump sum if the annuitant dies early.

Taxes and Other Considerations

An annuity purchased with some or all after-tax dollars will have a portion of each payment excluded from the annuitant's taxable income. The insurance company provides an exclusion ratio with the annuity payment quotes for the different options. Someone considering an annuity for retirement income should compare the after-tax return to other investment options. Annuitizing an annuity contract is an irreversible selection. Once an annuity payment choice has been made and the payments started, the contract cannot be changed, and there is no longer any lump sum available for other uses.

About the Author

Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.