What is Variable Annuitization?
Variable annuitization is a type of annuity option that makes the amount of income payments receivable by a policyholder vary, depending on the investment performance of the annuity. The option for variable annuitization must be specified by the policyholder during a particular phase of a contract, which is known as the annuitization phase.
During the annuitization phase, the policyholder can swap the accumulated value of their annuity in exchange for a steady stream of regular income payments. The regular payments may be guaranteed either throughout the life of the policyholder or for a given number of years.
- Variable annuitization is a type of annuity option that makes the amount of income payments receivable by a policyholder vary, depending on the investment performance of the annuity.
- The life of an annuity comprises two phases, i.e., the accumulation phase and the annuitization phase.
- Opting for a fixed annuitization means that, regardless of the performance of their portfolio, the policyholder will always receive the same amount of money per periodic annuity income payment.
What Does It Mean to “Annuitize”?
To annuitize means to “flip the switch” and begin to take income from an annuity. It enables the policy holder’s account to be converted from something that may or may not grow in value to something that becomes a steady source of income. Therefore, annuitization can be considered as a systematic payment plan.
Phases of an Annuity
The life of an annuity comprises of two phases, namely:
Phase 1 – Accumulation
In the accumulation phase, the investor is essentially adding into the annuity. All the earnings that may accrue to the policyholder during accumulation are exempt from being considered under the income for the purpose of the calculation of current income tax.
At the time of switching, when the policyholder wants to start receiving income from an annuity, they can either make withdrawals or annuitize their contract. Here they can choose to receive fixed or variable payments.
Phase 2 – Annuitization
During the annuitization phase, a fixed percentage or amount from each payment received by the policyholder is considered to be a non-taxable return. However, the remaining balance of the same is taxable. It is only valid for the income received for annuities that were purchased with after-tax dollars.
On the other hand, the annuity income receivable through withdrawals may be taxable as it is considered as income, and it may happen until all the earnings are withdrawn.
Upon the withdrawal of all earnings, they become non-taxable returns. This is because they are returns that accrued from the original investment in the annuity, which has already been taxed. For annuities that have been purchased using pre-tax dollars, all income subsequently accrued is treated as taxable.
Advantages of Variable Annuitization
Opting for a fixed annuitization means that, regardless of the performance of their portfolio, the policyholder will always receive the same amount of money per periodic annuity income payment. The amount remains constant over the life of the annuity.
Choosing a variable annuity means that the income the annuity holder will receive will vary according to the performance of the annuity investments. Thus, the choice of how to receive payments from an annuity depends on the amount of risk that the policyholder is willing to undertake compared to the amount of return they want or expect.
Disadvantages of Variable Annuitization
Purchasing an annuity requires locking in a set amount of funds into a specific product. The product may or may not perform as well as it was expected to. Moreover, the values of variable annuities are linked to the performance of financial instruments, such as mutual funds, which can be selected by the annuity owner.
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