Understanding the Annuitization Method

by Investing School on July 9, 2012

There are a number of different ways in which an annuity distributes substantially equal periodic payments. A distribution structure that gives the annuitant periodic payments over a specified time period, or for the rest of their life is called the annuitization method. Other ways to draw on an annuity can be the systematic withdrawal method and the amortization method. Additional options exist as well, but these are the most common.

When the account annuitizes, the entire balance is converted into an income stream. If the annuity was set up with an option for life then the income stream is guaranteed for the life of the annuitant, regardless of how long that might be.

The risk in this choice is that the annuitant will die before they have used up the total value of the annuity account. The insurance company that held the account would get to keep the balance. Conversely, if they annuitant lives way beyond their expected lifespan, the insurance company is required to keep paying the annuity at each period. This is the risk that the insurer takes.

Many annuities offer period-certain options or coverage for spouses. This decreases the risk of the funds not being paid out sufficiently as a result of a premature death while offering the spouse a degree of coverage as well.

It is worth pointing out that the IRS has specific minimal withdrawal rates based upon the federal mid-term rate which changes regularly and the mortality table which they publish. You are allowed to change your method of calculation one time.

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