Distribution It might seem like we’re going about this backwards, talking about distribution methods for annuities first, and the accumulation phase of deferred annuities second. If you keep your history in mind, though, it makes perfect sense. Annuities were designed around providing consumers with something they’d never before had: an income they could not outlive. As life expectancy after retirement began to rise, people developed real fears about outliving their assets. Enter the annuity, where you have numerous options to prevent just that occurrence. We’re going to take a look at some of the most popular options. Life vs. Term-Certain An annuity income stream can be structured to last for the annuitant’s lifetime, for a certain term, or both. Straight life or life-only annuities pay a benefit while the annuitant is alive, no matter how long that period may be. A term-certain annuity pays a benefit in an increment of years, usually not less than 5 and often in multiples of 10. A combination of the two could pay a lifetime benefit, but guarantee the payment amounts for a set period. The life-only option guarantees a payment for as long as the annuitant lives, but if the annuitant dies before the principal has been paid out, the remaining amount is forfeited. On the other hand, if the annuitant lives for an extremely long period of time, the payments continue unabated. Combining a life with a term-certain option can help lessen the risk (although adding options can decrease the amount of each payment; that’s true of all payout options). For example, a life option with a term-certain of 10 years would mean payouts would continue for 10 years whether or not the annuitant lives that long (payments would be made to a designated beneficiary). Should the annuitant live beyond the guaranteed 10 years, payments would cease at death, with any remaining principal forfeit. Because a life-only option carries the lowest level of risk to the insurance company, this option generally produces the most generous payment amounts. Another choice is to include a cash refund option, where any remaining premium is surrendered to a beneficiary upon the annuitant’s death, or an installment refund, where periodic payments continue to a beneficiary until the annuity has been fully liquidated. Joint Life Options The above payment options are predicated on a single lifespan. There are other options which allow for a payment based on the lifespan of two people. One rarely used option is a “pure” form of joint life, where payments cease when the first recipient dies. A more popular form is joint life with a survivor, where payments continue to the surviving contract holder. The difference between joint life and survivor and life with an installment refund is, primarily, the difference in payout amounts. In a joint life contract, payment amounts are usually slightly lower, because there is more risk to the insurer when calculating the life expectancy of two people rather than one. Term Certain A term certain option is exactly that: guaranteed payouts for a set period, usually 5 or more years. This option allows the asset to be quickly liquidated, and generally results in higher payout amounts because the span of time payments are expected to cover is defined. Payments continue regardless of whether the annuitant survives to the end of the term. Fixed vs. Variable One of the primary problems facing an annuitant is inflation. Annuitization (converting the annuity to a series of payments) can be either fixed or variable, and each option has its own points of contention. Fixed annuitization creates a rigid set of payment amounts; once you’ve determined that your monthly payout will be $786, for example, it will be $786 dollars per month for the rest of your life. Variable annuitization, on the other hand, can provide you with potentially greater payment amounts because it links your payments to the performance of an account. The catch here is, of course, that if your account underperforms, your payment amounts may be reduced. Taxation How your annuitized payments are taxed depends on something called the exclusion ratio. A portion of each payment is considered a return of your principal, and isn’t taxed. The interest earnings which make up the rest of your payments are taxable. The exclusion ratio lets you know which portions of each payment are taxable and which are not. Here’s the magic formula:  Investment in the Contract   Expected Return  Your paid premium (or “basis”) represents your investment in the contract for the formula. The amount of income you expect to receive based on the annuitization strategy you’re following is the expected return. The ratio returned by the formula tells you what percentage of your payments will be non-taxable. The way in which your expected return is calculated can vary by annuity product, but everything should be made clear to you during the annuitization process.