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What is a Split Annuity?

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  • Written By: J.M. Densing
  • Edited By: Jacob Harkins
  • Last Modified Date: 02 December 2016
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A split annuity is an investment strategy that contains at least two annuities working together to achieve a certain purpose. The purpose of a split annuity is to provide an income stream, and to re-build principal at the same time. This is accomplished by investing in both an immediate annuity and a deferred annuity at the same time, with one initial premium payment. One annuity pays out income while the other generates interest to rebuild principal to the original amount invested. This strategy has several benefits and a few drawbacks.

When investing in a split annuity, two types of annuity are purchased, one being a single premium immediate annuity. Single premium means that it is purchased with one lump sum, rather than making payments while an immediate annuity is one that begins paying out at the time of purchase, with no waiting period. In this way, the investor is able to start receiving income from his or her investment right away.

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The other type of annuity purchased when using a split annuity strategy is a deferred fixed annuity. Deferred means that the payouts from the annuity are delayed for a set period chosen by the investor, and the term fixed refers to the fact that the delay period is fixed and can't be changed. The money in the deferred annuity simply sits and grows. The time period is calculated so that the entire principal used to fund both annuities is replaced by this one growing at a fixed interest rate.

Both annuities in a split annuity strategy have limited terms. They are carefully calculated to end at the same time, once the original principal has been restored. An advantage of the immediate annuity also being term limited is that this allows larger payments from the single investment. Payments from a lifetime annuity would be much smaller. Once the term ends, the restored principal can be invested again in another split annuity, or in another way that will benefit the investor.

The strategy of using a split annuity is a conservative one, often marketed to retirees, but it's ideal for those who are concerned about outliving their money. A drawback is that the income stream generated will be much smaller than if the entire investment were generating the income. However, once the term is complete, the entire principal is restored and can be invested again. There are also several tax benefits to the strategy, most of each payment from the immediate annuity is tax exempt because it is return of principal, and the interest on the deferred annuity is tax deferred.

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