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  • Brian Wiley

Should You Annuitize Your Non-Qualified Annuity?

Updated: Aug 17, 2019


Disclaimer: I do not sell annuity products and rarely recommend them. However, many of you have them. So here is my Pro/Con list.


Annuitization is the process of converting an annuity investment into a series of periodic

income payments. Annuities may be annuitized for a specific period or for the life of the annuitant. Annuity payments may only be made to the annuitant or to the annuitant and a surviving spouse in a joint life arrangement. Annuitants can arrange for beneficiaries to receive a portion of the annuity balance upon their death.


A non-qualified annuity is funded with after-tax dollars, meaning you have already paid taxes on the money before it goes into the annuity. When you take money out, only the earnings are taxable as ordinary income.


There are Pros & Cons to annuitizing your non-qualified annuity. Here is my take.


Market Fluctuations

Pro: Market fluctuations will no longer affect the values. Once you turn it into a stream of payments, the payments will remain level until you both pass away. (I hate even thinking of that by the way).

Con: The annuity, while not being annualized, has all the upside potential of the market. Once annualized, you are removing the ability to see the value, or income from the value, increase. You are, in essence, locking in the value now, and choosing to spend that value over the rest of your lifetime(s).


Ordinary Income

Pro: A portion of each payment is not considered ordinary income. Only about 53% of the payment will be taxable as ordinary income. Since annuities require gains out first, this is a decent way to get a mixture of gains and basis as you take the money.

Con: Adding ordinary income to your income scenario is currently at your discretion. You can take money when you want it, which allows us to minimize income in certain years, in case of a tax issue, or health qualification (such as Peter’s discounted medication). We will not be able to stop these payments. This is the other 47% of the payments which is treated as ordinary income on your tax return.


Company

Pro: The best quote you received came from a very highly rated company (2nd best rating of 15 rating levels). So, it appears the company is in good financial shape.

Con: Ratings on companies are a snapshot of time by someone, or some firm, we do not know. There may be conflicts between the insurance company and the analyst, but it's all we have to work with. Additionally, while the ratings might be strong (now), there is no guarantee the ratings, or the company, will be strong moving forward. If North American cannot make the payments, then they would default. The payments are only as good as the claims paying ability of the underlying insurance company. Who knows what could happen, right?


Stable Income

Pro: The stable income continues until the second death. If one of you lives to some crazy age, it might help provide some peace of mind knowing the income will continue, even if other assets have been spent down.

Con: 100% survivorship means they pay until the 2nd death. If both of you die shortly after annualizing, there is no value left for your heirs to inherit.


In the end, this is certainly something to take a close look at. Typically, annuitization rates are affected by two primary factors (aside from the mortality tables); the interest rate environment and the annuitant’s age(s). The higher the interest rate environment, the less money it takes to buy a certain monthly payment. Rates are low right now, so the payment you are being quoted is likely much lower than if we had higher inflation and interest rates. Secondly, every year you age, the rates will go up because you get closer to mortality age. So, if you punt until after you both turn a year older (January), then the rates should increase. So, these two factors together, I would suggest we wait until after January to give this another look. Since the Fed dropped rates yesterday (which makes no sense to me), it might not be in your favor to annualize right now. Perhaps the rates will increase over the next year or two? If so, then the payments from this will go higher.

Brian

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