There are different options when an annuity reaches its maturity date, but how that plays out has a lot to do with how the annuity was set up when it was started. Annuities are contracts between you and the insurance company, where the details – often including maturity options – are spelled out ahead of time.
The process of maturity with an annuity is unlike that of more traditional investments like certificates of deposit. The process of taking income from an annuity – what might be called “maturity” with other investments – is referred to as annuitization. That process is largely determined by the terms of the annuity contract.
Since an annuity works much like an IRA, it allows for tax deferral of investment income which becomes taxable when distributed. And just as is the case with an IRA, you cannot withdraw funds from an annuity before age 59 ½, and you must begin taking distributions no later than age 70 ½.
Failure to do so in either case will result in penalties (the IRS 10% early withdrawal penalty, for starters).
Here are the more common arrangements and options in regard to maturity distribution methods.
This is a class of annuity where you put a large lump sum into the contract, and the insurance company begins paying you an immediate income. Depending upon the contract, this can allow you to receive a guaranteed income for a specific period of time, or even for the rest of your life.
You can direct the annuity to provide you with either fixed level payments, or with variable payments depending upon the performance of the underlying investments.
You can also set up an immediate annuity with a deferred annuity (which we will discuss below). This is done by converting the deferred annuity to an immediate annuity upon maturity.
A deferred annuity works much like an IRA. You fund it over a number of years – which is spelled out in the annuity contract – and then begin taking income at the end of the term.
You can have the annuity then pay you an income under whatever terms are spelled in the contract. It can be an annual distribution, semiannual, quarterly, or monthly.
This is probably the most interesting annuity of all, and the most complicated as far as maturity options are concerned. The basic purpose of the longevity annuity is to prevent the annuity owner from outliving their money. This is a common concern, even among elderly who are well-to-do.
Like all annuities, longevity annuities can be set up with various provisions. However, you typically must wait until you reach the age of 80 before receiving income distributions from the contract.
At that point, the insurance company will begin making income payments to literally last for the rest of your life, virtually eliminating the possibility that you might outlive your money.
This delay in the payment of income is also why the insurance company is able to guarantee you that income. Since roughly half the population will not reach 80, the insurance company will be the winner in 50% of longevity annuity contracts. And I mean the winner!
Should you die before you begin receiving income payments,the insurance company will keep your investment in the annuity. No, the money remaining in the contract will not be paid out to your heirs and beneficiaries.
A longevity annuity is something like a bet between you and the insurance company. You’re betting that you will live past 100, while the insurance company is betting that you won't make 80.
Under the terms of a longevity annuity, not only will income payments be delayed until extreme old age, but there is a very good chance that neither you nor your heirs will ever collect a penny of the money that you invested in the contract.
Annuity Distribution Options
To summarize the distribution options, when an annuity matures – or annuitizes – you will generally begin taking income payments as of a predetermined date that is spelled out in the annuity contract. The receipt of income payments can be monthly, quarterly, semi-annual, annual, or whatever you agree to with the insurance company.
There are also tax implications connected to annuity income payments. Much like a Roth IRA, there is no tax levied on the portion of your annuity income payments that represents your contributions to the annuity contract.
That is because the contributions were not tax deductible when they were made. However, unlike a Roth IRA, the earnings that have accumulated on your annuity will be taxable as ordinary income in the year received as income.
Watch Out For High Fees and “Gotcha Provisions”!
We’ve already discussed the potential to lose your entire annuity investment on a longevity annuity if you die before you begin receiving income payments from the plan. But annuities have other gotcha provisions, as well as some pretty stiff fees.
Annuities that are invested in the insurance company equivalent of mutual funds can be especially problematic. For example, insurance companies offer equity indexed annuities, that are based on an underlying index, such as the S&P 500.
The problem is they typically do not include dividend distributions in your return. They may also have caps on the amount of capital gains income that you can have in any given year. Once again, it is very important understand that annuities are contracts, and contain very specific provisions that will govern what your rate of return will be.
As such, annuity fund type investments should not be confused with mutual funds and exchange traded funds that are popularly available to the general investment public.
Fees on annuities, and especially those invested in funds, are almost universally higher than what is found elsewhere in the investment world. For example, an insurance company may charge an annual commission on your holdings in a fund type investment.
They may also impose a surrender charge, and it can be as high as 20 percent on equity indexed annuities. Unlike many mutual funds that also impose back-end load fees, surrender charges on annuities can be in effect for many years.
Annuities can be great investments to either supplement your retirement income, or to provide yourself with a guaranteed income flow. Just be sure you understand that you’re entering in the contract – one that will include dozens of details – and that you need to be familiar with every one of them before proceeding with the contract.
If your current annuity is about to reach it's current maturity date, you might want to consider doing a rollover to a self-directed IRA.