First, it's important to understand the options you have in regards to the way you want your money to be taxed, in regard to your annuity. As the annuitant, you have two options in this matter. The first option is an "immediate annuity", which is popular for clients who have recently retired and are looking for source of lifetime income to supplement social security. This money is taxable as it grows.
The second option, and more popular for annuitants below 59 ½ years of age, are deferred annuities. Deferred annuities are fairly self explanatory, in that their taxation is "deferred" until the owner begins taking payments on the policy. Contrary to immediate annuities, deferred annuities are seen more as a method of wealth accumulation.
As is stated above, deferred annuities grow tax deferred for the duration of time before the client starts taking payouts. This is also called the "accumulation phase". When the duration phase is complete, the client will begin to take payments on the policy. The process of taking these payments is called "annuitization."
Types of payment options
There are two types of payment options that the client is able to choose for their annuity. These options are:
1) Larger payments for a set number of years, or,
2) Smaller payments guaranteed for life.
Once the annuitant chooses the time period that they want to receive their money (one of the two previously listed options), they then have the choice of obtaining payments every month, every 3 months (or quarter), or once per year (annually). Once the payment options have been chosen by the client, the major indicator for what the payments will look like is the overall "accumulation value" (initial premium+bonuses+any contributions – less any withdrawals).
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It is important to understand that the payout options are going to vary based on the type of annuity that you purchase (i.e. fixed, indexed, or variable). The number one question that you need to ask yourself when you are looking at which annuity to purchase is "What level of risk am I willing/able to take with this money?" The next section will take you through the payment structure of the various types of annuities.
Pay outs on immediate annuities begin "immediately." Due to the fact that the IRS considers the payouts on immediate annuities to be "return of premium", the tax liability of this type of policy tremendously favors the client. The only money that is taxed is the interest that is accrued by the annuity.
Due to the fact that immediate annuities are most commonly used as a supplement of income in retirement, the most frequently purchased immediate annuities are fixed. This guarantees a set amount of income for a set amount of time, which offers stability in a client's "post work" years.