Annuitization is the process of converting an annuity contract's accumulated value (lump sum) into a series of periodic income payments. Once annuitized, the decision is generally irrevocable.
Payout options:
| Option | Description | Key Risk | |---|---|---| | Life only | Payments for life; stop at death | Short life = poor value | | Life with period certain | Life payments + minimum guaranteed period (e.g., 10 or 20 years) | Less income than life only | | Joint and survivor | Payments continue while either annuitant is alive | Lower payment per period | | Period certain | Payments for a specified time (e.g., 20 years); go to estate if annuitant dies early | Outliving the payments | | Lump sum | Withdraw accumulated value; not true annuitization | Tax/penalty exposure |
Tax treatment on annuitized payments: - Each payment is part return of basis (tax-free) and part earnings (ordinary income). - Exclusion ratio: Non-taxable portion = investment in contract ÷ expected return. - Once the basis is fully recovered, all remaining payments are 100% taxable.
Variable annuity annuitization: - Payments based on performance of separate account. - Assumed investment rate (AIR): If sub-account performance exceeds AIR, payments increase; if below AIR, payments decrease.
Annuitization vs. systematic withdrawal: - Annuitization provides guaranteed income for life (longevity protection) but surrenders the account value. - Systematic withdrawal retains control of assets but risks outliving the money.
> Exam tip: The exclusion ratio determines what portion of each payment is tax-free. Life-only payout offers the highest payment per period but no survivor benefit. Variable annuity AIR is a key Series 7 concept.