Thursday, January 11, 2007

Annuities Settlement or Payout Options

What are your settlement options (or payout options)? There are several settlement options you can pick. First one is called the straight life annuity. This is the largest monthly payout option of all three. What this option do is that you want to receive monthly payments for life and don't want anyone else to have it in case you die. If you die before your life expectancy, the insurance company retains the balance of the account. If you outlive the life expectancy, then you have receive more money than what was expected to pay out. It's a high risk scenario for you and the insurance company. You hope to live longer than expected and the insurance company hope you die sooner than expected.

Second settlement option is life annuity with period certain. That means if you die during a certain period of time, your beneficiary will receive the rest of the annuity payments until the period ends. For example, if you elected a life annuity with 10 year period certain and you die during the fifth year, the insurance company will continue paying your beneficiary for the next 5 years. Remember, annuities pay you, the owner, for life. So after the tenth year, you will continue to receive payments, but your beneficiary will not in the event of your death. Periods can be as long as 15 years or 20 years in some companies.

The third settlement option is called Joint and Survivor annuity. That means, you will be paid a monthly benefit as long as you live. Upon your death, a predetermined percentage of your monthly payout will continue to be paid to your beneficiary until that person dies. The percentage varies between companies and can be low as 50% or high as 100%. You may be able to negotiate this percentage. The higher the percentage you pick, the lower the monthly payments you will receive. This settlement option has the least risk to you and therfore, has the smallest monthly payment of all three options. "Lower risk = lower rewards. Higher risk = higher rewards."

The forth settlement option is called Lump Sum Settlement Annuity. As it says, you want to take the whole balance of your account in one lump sum. This puts your investments in your hands and you accept all risks on what you plan to do with it. You will avoid the risk of getting less thatn a full return of your invested capital plus earnings. The drawback of receiving a lump sum is that the IRS will know that you have receive large amount of income and this may push you up in a higher tax bracket.

For example lets say the value of your account at the time you taken the lump sum was $150,000. $65,000 of it was from your own contributions and the other $85,000 was from earnings. If you taken the lump sum of $150,000 you will need to report the $85,000 as ordinary income on your 1040 tax form. Depending on what your normal income was, this may put you in a higher tax bracket than you normally were. Most people will not take the lump sum option because they don't know what to do with all the money. They can put it in a bank account, but they will lose the earning power that the money can generate if it were invested in the stock market.

Another payout option is called installments of designated amounts. That means a specified amount is paid every month until the account is exhausted, after which no further payments are paid. Its similar to a mutual fund withdrawal. Another payout option is called investment income, which the principal is left intact and payments only consist of the earnings. At death, the principal amount is paid in one lump to the beneficiary. Both of these payout options benefits the beneficiaries more than the primary annuitant.