What Happens When an Annuity Ends? Your Options

An annuity is a contract, typically with an insurance company, providing a steady income flow, often for retirement. Understanding its conclusion is important for long-term financial planning. This article explores scenarios and implications when an annuity contract reaches its conclusion or maturity.

Understanding Annuity End Points

Annuity contracts have specific end points, dictating how payments conclude or assets are distributed. A common type is the fixed period annuity, paying for a predetermined number of years. Once this period, such as 10 or 20 years, concludes, payments cease, or any remaining contract value is distributed to the owner or beneficiaries.

Lifetime annuities provide payments for the annuitant’s life, continuing until death. Joint and survivor annuities pay until the last surviving annuitant’s death. A “life with period certain” annuity guarantees payments for a minimum period, with beneficiaries receiving payments for the remainder if the annuitant dies earlier.

For deferred annuities, with an accumulation phase before payments begin, the contract ends if the annuitant dies during this initial phase. A death benefit is paid to designated beneficiaries, who receive the accumulated value or a guaranteed minimum amount. A deferred annuity concludes when it matures, transitioning from accumulation to distribution or payout.

Options for Receiving Funds

When an annuity reaches its end point, several options are available for receiving accumulated funds. One common choice is annuitization, converting the accumulated value into a guaranteed stream of periodic payments. This can be structured as a single life annuity, paying for one individual’s lifetime, or a joint and survivor annuity, extending payments over two lives.

Another annuitization option is the period certain annuity, guaranteeing payments for a specific duration, such as 10 or 20 years, even if the annuitant dies before the period ends. For immediate access, receiving the entire remaining value in a single lump sum is an option. This provides complete control but may have different tax implications.

Systematic withdrawals offer a flexible alternative, allowing regular, non-annuitized withdrawals from the annuity’s value. Remaining funds can continue tax-deferred growth within the contract, providing continued income and potential growth. Annuity owners can also consider a rollover or transfer of funds, such as a 1035 exchange, for tax-free transfer between annuity contracts. Funds can also remain within the annuity contract, continuing tax-deferred growth without immediate annuitization or a lump sum.

Tax Implications of Annuity Distributions

Tax implications of annuity distributions depend on whether the annuity is qualified or non-qualified. Qualified annuities are held within tax-advantaged retirement plans (e.g., IRAs or 401(k)s), where contributions were tax-deductible or pre-tax. Distributions from qualified annuities are taxed as ordinary income, similar to other retirement account withdrawals, because funds have not yet been taxed.

Non-qualified annuities are funded with after-tax money, so principal contributions have already been taxed. Distributions are taxed using an “exclusion ratio,” designating a portion of each payment as a tax-free return of principal, while the earnings portion is taxable as ordinary income. If a lump sum withdrawal is taken, the IRS applies the “Last-In, First-Out” (LIFO) rule, meaning earnings are withdrawn first and are fully taxable until depleted.

An additional 10% tax penalty applies to withdrawals made from annuities before the owner reaches age 59½. Exceptions to this penalty include withdrawals due to death or disability of the owner, or if the distributions are part of a series of substantially equal periodic payments.

When death benefits are paid to beneficiaries, their taxation differs. For non-qualified annuities, only the earnings component is taxable to the beneficiary, while for qualified annuities, the entire death benefit is taxable as ordinary income to the beneficiary. Annuity distributions are reported to the IRS on Form 1099-R.

Preparing for Your Annuity’s Conclusion

As an annuity approaches its conclusion, proactive steps ensure a smooth transition and optimal financial outcome. Locate and review your annuity contract, which outlines its specific terms, payout options, and guarantees. Understanding these details is key to making informed decisions.

Contact your annuity provider well in advance of the maturity date. The insurance company can confirm contract details, explain options, and provide necessary paperwork or forms for distribution or changes. Early communication helps avoid last-minute complications and ensures administrative requirements are met.

Seek advice from a financial advisor to evaluate the financial and tax implications of different payout options based on your circumstances. An advisor can integrate your annuity payout into your broader financial plan, considering income needs, investment goals, and overall tax situation. Ensure your beneficiary designations are current, as this determines who receives any remaining funds upon your death. Aligning payout decisions with your retirement and financial objectives helps ensure the annuity serves its purpose.