All Annuity Income Is the Same

Editors' pick: Originally published Nov. 15.

Regardless of what type of annuity you choose to provide a guaranteed lifetime income stream, the payout and benefit proposition are always the same.

All annuity income is return of principal plus interest.

Whether you buy an SPIA (Single Premium Immediate Annuity), DIA (Deferred Income Annuity), QLAC (Qualified Longevity Annuity Contract), or attach an Income Rider to a Variable or Indexed annuity, all income from an annuity is a combination of return of principal plus interest.

I know that I just undercut a ton of "too good to be true" sales pitches, but this is the annuity contractual fact. Variable and indexed annuity promoters want you to believe their non-guaranteed growth promises will "offset" the income taken out, but that's long-term nonsense that never pans out. The contractual reality is that when you turn on an annuity income stream, your account value is going to go down.

This reduction somewhat irrelevant because the carrier is responsible for paying regardless of how long you live. That's why you own the annuity in the first place!

You have two annuity income choices: annuitization or withdrawal.

Depending on the type of annuity you choose, the guaranteed income stream can be structured using either annuitization or the withdrawal method.

SPIAs, DIAs, and QLACs are all "annuitized" strategies. SPIAs and DIAs used in a non-IRA account can provide a significant tax benefit because the return of principal part of the income is not taxed. Only the interest portion is subject to taxation. Annuitization is akin to ripping the knob off a water faucet. Once you do that, the water is going to flow. This correlation applies to an annuitized income stream. Once you start the lifetime payments (i.e. "annuitize"), only your death will stop the money from hitting your bank account.

Most Income Riders available use a guaranteed withdrawal method instead of annuitization. By the way, "withdrawal" means subtraction, and your income amount is deducted in full from your annuity contract every time you receive a payment. The income stream is taxed "LIFO" (Last In, First Out) using a withdrawal strategy, which means gains are taxed first at ordinary income tax levels.

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