Many people are familiar with the requirement to begin taking distributions from Individual Retirement Accounts (IRAs). The purpose of this IRS rule is to end a portion of the tax deferred growth and begin paying taxes on the monies. Non-qualified annuities are similar to IRAs in that they defer taxes on investment growth. The difference is that you do not have to take taxable distributions from this type of account at age 70 1/2.
Non-qualified annuities mature at a contract specified age or date, most typically at age 85. It is at this age or date that a policyholder must choose how to begin taking income from the account. The choices are varied and might include immediate annuitization, a period certain payout, delaying payment, or distributing the annuity in full paying all deferred taxes in the year of distribution.
Immediate single life annuities have advantages and disadvantages and should be evaluated carefully. One disadvantage is that, as life expectancy shortens after age 85, the probability of getting the full value of the annuity returned to you during your lifetime diminishes. In this case, the insurance company will probably be compensated well for this choice.
To increase the return of monies during their lifetime, many people consider a period certain annuitization. In this choice the value of the contract, at a specified interest rate, is used to calculate a fixed payment for a fixed period of years. Period certain annuities may be an overlooked option for many policy holders. The hidden treasure in older annuity contracts is that the interest rate may be much higher than today’s interest rates. In addition, contract owners can name a beneficiary to the fixed income stream should they die prior the end of the fixed period.
In some cases, an income stream is more desirable than a lump sum of money. For example, a couple in a second marriage may want to provide for their current spouse but not want these monies to continue to the spouse’s heirs. The ability to name the primary and contingent beneficiaries to the income stream gives the annuity owner the ability to direct these afterlife income streams during lifetime.
Finally, delaying the payment may actually result in being forced to accelerate the full payment of the annuity if you outlive the term of the continued income delay of the contract. For instance, if you delay the payment for 10 years at age 85, and you live to age 95, you may then be forced to take the total annuity value in one lump sum incurring a potentially large tax consequence.
The maturity of the annuity at age 85 may actually be a gift to annuity owners to further contemplate their exit strategy of this tax deferred investment.