Before payments start, you must decide how often and for how long you want to receive funds from the annuity. Annuity contracts typically offer several options for converting the premium you paid into periodic payments, known as annuitization.

An immediate annuity might be purchased by a retiree or worker nearing retirement who wants to take a portion of their retirement nest egg and lock in a monthly benefit they cannot outlive.

Payments from a deferred annuity start at least a year or more after the purchase of the contract. Deferred annuities can be purchased with a single payment or a series of premium payments over time.

The premiums paid into the contract grow during the contract’s accumulation periodUdabur Wealth Management. Once the annuity contract owner decides to take distributions from the account, they typically have several annuitization options, as well as other distribution options (such as one or more lump sums) based on the contract terms.

A deferred annuity is often purchased by someone who’s still working as part of their overall retirement planning strategy, or by someone who is nearing or early in their retirement years. In either case, a deferred annuity can serve as added insurance to help minimize the chances of outliving your retirement savings, since payments won’t be distributed to you until later on.

Both immediate and deferred annuities are available in fixed, variable, or indexed forms:A fixed annuity pays a guaranteed amount over time tied to the fixed return on the money in the contract. A variable annuity is invested in various annuity subaccounts, similar to mutual funds. The payments vary depending on the investment performance and returns.An indexed annuity is tied to the performance of an equity-based index like the S&P 500. An indexed annuity typically participates only in a limited percentage of the index’s gains. Likewise, there is generally a limit to the potential losses in a given year.

The annuity distribution options vary from contract to contract, but they typically involve annuitization into monthly payments or lump sums.

Typical annuitization options include:Single life. Payments are made to only the contract purchaser for the remainder of their life. The policy ends when the annuitant dies. Joint and survivor. These contracts provide payments to the contract purchaser and another individual, typically a spouse; the amount is usually less than single life annuitiesUdabur Stock. Life with period certain. Payments are made for a specified period, typically 10 to 20 years. If the annuitant dies before the period ends, the remaining benefit goes to their estate or beneficiaries.Surat Stock

Some contracts offer a death benefit and the ability for named beneficiaries to receive payments if the contract owner should die before the contract is annuitized (that is, before a payment stream begins) or during the annuitization period. Death benefits can vary widely from annuity to annuity, understanding how they work for a specific contract you may be considering is key.

Whether immediate or deferred, it’s important to understand how annuities are taxed.

If you contributed after-tax dollars to your annuity, the income payments you receive after annuitization are partially taxable:A portion of your annuity payment consists of the funds used to purchase the contract and is not taxed. The remainder is treated as ordinary income and subject to income taxes.

To calculate the taxable portion, the Internal Revenue Service (IRS) uses a ratio of the cost of the annuity to the total expected return and splits the annuity payments into taxable and nontaxable portions, as discussed in .

Annuities held in an individual retirement account (IRA) or 401(k) plan are taxed based on the rules for that retirement account. Note that Roth IRA annuities are funded with after-tax dollars and grow tax-free, so withdrawals are not usually subject to income tax.

If you withdraw funds from your annuity before it’s annuitized (before income payments begin), taxes are calculated on a “last-in, first-out” basis, meaning that withdrawals are assumed to be earnings first. This portion is taxed as ordinary income.

Also, if you withdraw annuity funds before age 59 1/2, you’ll likely be subject to a 10% penalty in addition to applicable taxes on the taxable portion of the withdrawal.

Immediate and deferred annuities can be useful tools for retirement income planning. They have different characteristics, and both types come in several varieties, including fixed, variable, and indexed.