Payout Phase: What It is, How it Works, Types

What Is the Payout Phase?

The payout phase in an annuity is the phase when payments are made to the annuitant. These usually distribute on a monthly basis and last for the lifetime of the annuitant. An annuity is a financial product that pays an investor or recipient a stream of payments at some point in the future.

The investor deposits money into the annuity, which is called the accumulation phase. When the investor begins receiving payments, which is typically in retirement, the annuity has entered the payout phase. The size and frequency of the payouts can vary, depending on the type of annuity the investor has purchased. The payout phase is also called the annuitization phase.

Understanding the Payout Phase

The payout phase comes after the accumulation phase when an annuitant builds assets for retirement through their annuity portfolios. Once withdrawn, the income received by a retired investor is taxable income as well as any of the earnings or investment from over the years. In other words, any payouts are taxed as ordinary income.

Most annuities have a minimum age at which an annuitant can begin the payout phase without incurring an early withdrawal penalty. The investor can also include provisions to continue the payments until both the annuitant and their spouse are deceased. However, the annuitization process is irreversible once it has entered the payout phase, meaning the annuitant cannot continue to build assets and increase the value of their annuity portfolio.

When annuitants are ready to begin receiving payments from their annuities, they notify the insurance company of their decision to do so. At the beginning of the payout phase, the investor may receive a lump-sum payment or may choose to receive the payout as a stream of payments at regular intervals. Actuaries use mathematical models and life expectancy tables to compute payment amounts, which will last for the life of the annuitant: the longer one waits, the larger one's payments will be.

Types of Payout Phases

If the investor chooses a stream of payments versus a one-time payout, they may choose to receive payments that are fixed or payments that vary based on the performance of various investment options such as a mutual fund. The amount of each periodic payment will depend, in part, on the time period selected for receiving payments.

When the investor decides to annuitize the contract, a specific payment option, which usually cannot be changed in any way, is locked into the annuity. The value of the account can either be drawn in a lump sum or annuitized over the investor's lifetime.

There are several annuity payout options available, including the following:

Life Annuity

A life annuity option usually provides the largest periodic payments since the payments are spread out over the life of the recipient. The life annuity is helpful since it helps the retiree from outliving their savings, meaning they don't run out of money.

Life Annuity with Period Certain

Life annuity with period certain guarantees the payments over a certain period of time in addition to lifetime payments. Also, the beneficiary will receive payments for the remainder of a certain period if the annuitant dies. This option helps in case the annuitant dies before the guaranteed period has passed. The annuity payments would continue for the guaranteed period, such as 10 years, with the beneficiaries as the recipients.

Joint Life with the Last Survivor

Joint life with the last survivor covers two or more people, which is usually a husband and wife. The annuity continues payments to the survivor after the death of the first person.

Life Contingency

Life contingency is an annuity with an attached death benefit, which is a payout similar to a life insurance policy.