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What is Annuitization?

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  • Written By: Jessica Ellis
  • Edited By: Bronwyn Harris
  • Last Modified Date: 29 November 2016
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Annuitization is the process of converting a lump sum into a stream of steady payments over time. This can be done for many different types of earnings and winnings, including retirement income, pensions, lottery winnings, and inherited sums. Annuitization guarantees a regular payment for either a set period until the sum is paid out, or in some cases until the death of the receiver.

Often, annuitization is used for the distribution of retirement accounts. Rather than taking a single lump payment, a retiree can annuitize earned and invested retirement funds to replace the monthly income that will disappear upon retiring. Generally, a retirement account such as an IRA can be paid into over a career, and matures, or becomes available for withdrawal without penalty, once the owner has reached a certain age. Earnings are usually tax-deferred, meaning that they are not taxed until they are removed. Some people choose annuitization if the taxes paid on yearly payments will be lower overall than those paid on a lump-sum withdrawal.

If a person needs to increase income before retirement, it may be possible to annuitize retirement accounts before reaching the proscribed age of retirement. Any withdrawals may be subject to tax penalties, but taking annuitized payments may lessen the tax burden as compared to withdrawing the entire lump sum of the account. If financial conditions occur, a person may be able to stop the annuitization and go back to growing the account for a future retirement.

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Annuitizing an account may guarantee payments for a fixed period or until the sum runs out. Some forms of insurance, called annuities, may guarantee payments until the death of the policy owner, which can ensure an income for life. Depending on the structure of the account, an account holder or policy owner may be able to name beneficiaries, such as a spouse or children, should he or she die before the sum is completely dispersed. In these cases, the annuitization payments would continue until the account was exhausted, but be transferred to the named beneficiaries for use.

Lottery winnings may sometimes be distributed through annual payments rather than a lump sum. This is often done with extremely high payout amounts, such as those over one million US Dollars (USD). The annuitization of lottery winnings can sometimes give the winner a higher percentage of the amount won overall, as the tax rate may be lower for annual installments than for a lump sum. Another potential upside to annuitization with windfall lottery winnings is that a winner is less able to overspend and may be better able to manage smaller sums distributed over time.

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