When you annuitize a variable annuity, the insurance company converts your accumulated account value into a stream of periodic payments, usually for life, and the decision is permanent. Your dollar balance is exchanged for a fixed number of “annuity units” whose value rises and falls with the sub-accounts, so each check varies with the markets. You give up access to the lump sum, most of the riders you were paying for disappear, and the payout option you pick on day one governs everything that follows.
How the Contract Changes
During accumulation, a variable annuity behaves like an investment account: you pick sub-accounts, the balance moves with the market, and you can withdraw money subject to surrender charges and possible tax penalties. Annuitization ends all of that. From that point forward you own units rather than dollars. The number of units you hold never changes. The value of each unit is recalculated each period based on sub-account performance, and your payment equals your fixed unit count multiplied by the current unit value.
That is what distinguishes a variable payout from a fixed one. The fixed version pays the same amount every month. The variable version keeps you exposed to the market, which is the price of keeping some growth potential in retirement.
The irreversibility catches people off guard. You cannot undo annuitization, switch payout options later, or pull out a lump sum for an emergency. Whatever flexibility you keep is whatever your chosen payout option built in — a survivor benefit, a guaranteed period, or a refund feature. Everything else is locked.
What You Lose
This is where most people underestimate the cost. Annuitization typically terminates any living benefit and death benefit riders attached to the contract. A guaranteed minimum death benefit or enhanced death benefit you bought during accumulation generally disappears once payments begin. The death benefit during the payout phase is whatever your settlement option provides, such as period-certain payments to a beneficiary, not the separate rider you may have been funding for years.
You also lose liquidity entirely. During accumulation most contracts let you withdraw up to 10% of value annually without surrender charges. After annuitization that option vanishes. A $50,000 medical bill cannot be pulled from the contract. Your only income from it is the periodic payment.
Check for a Lifetime Withdrawal Rider First
Before committing, see whether your contract has a guaranteed lifetime withdrawal benefit (GLWB) rider. A GLWB produces lifetime income similar to annuitization but lets you keep access to the remaining account value, and any balance at death passes to beneficiaries. The guaranteed income is usually lower than full annuitization would produce, and the rider carries its own annual fee, but the flexibility often justifies the tradeoff. Systematic withdrawals without a guarantee are the other alternative, with the risk of outliving the money.
Choosing a Payout Option
The payout option determines how long payments last, how large they are, and what happens to the money when you die. It is the single most consequential choice in annuitization, and it cannot be changed later.
Life Only
Life only pays the largest check because the insurer’s obligation ends completely at your death. Nothing passes to heirs. Annuitize a $500,000 contract and die six months later, the insurer keeps the rest. It fits people with no dependents or with other assets earmarked for heirs. It fits poorly if a spouse depends on your income.
Life With Period Certain
Payments continue for life but with a minimum guarantee period, commonly 10, 15, or 20 years. Die inside the period and the beneficiary receives the remaining payments until it ends. Outlive the period and payments continue for life with nothing left for heirs. Longer guarantees produce smaller checks because the insurer takes on more risk. A 20-year certain pays less than a 10-year certain, which pays less than life only.
Joint and Survivor
Designed for couples. Payments continue until both lives have ended. The initial check is lower than a single-life option because the insurer is covering two lifetimes, and how much lower depends on the survivor percentage. A 100% survivor option keeps the payment level after the first death; a 50% survivor option cuts it in half. For qualified plans the IRS requires the survivor percentage to fall between 50% and 100% of the original payment.1Internal Revenue Service. Retirement Topics – Qualified Joint and Survivor Annuity Higher survivor percentages mean lower initial payments.
Refund Options
Cash refund and installment refund features guarantee that if you die before receiving payments equal to your original investment, the difference goes to your beneficiary. A cash refund pays the shortfall as a lump sum. An installment refund continues periodic payments until the full investment has been returned. The installment version typically produces slightly higher income during your lifetime because the insurer pays the refund gradually.
Period Certain Only
A period-certain-only payout runs for a fixed term such as 15 or 20 years regardless of whether you’re alive. It is not a lifetime option. Live past the term and payments stop. It behaves more like a structured withdrawal plan than true annuitization, with no longevity protection. Payments remaining at your death go to your beneficiary.
How the Numbers Are Set
Three factors drive the size of the initial payment: your accumulated contract value, the actuarial mortality factor for your age and chosen payout option, and the contract’s Assumed Interest Rate (AIR). The older you are at annuitization, the fewer payments the insurer expects to make, so each one is larger.
The Assumed Interest Rate
The AIR is a benchmark return written into your contract that the insurer uses to set the first payment. Think of it as the breakeven line. The initial payment is calculated as if the sub-accounts will earn exactly the AIR going forward. Every subsequent check depends on how actual returns compare to that benchmark.
Beat the AIR in a given period and the next payment goes up. Trail it and the payment goes down. Match it and the payment holds. A lower AIR means a smaller first check but an easier hurdle for raises later. A higher AIR means a bigger first check but a tougher hurdle. AIRs typically fall in a conservative range, often 3% to 5%, so that payments have a reasonable chance of growing rather than shrinking.
Why Payments Fluctuate
Your unit count is fixed at annuitization. What moves is the dollar value of each unit, which the insurer recalculates each period based on sub-account performance relative to the AIR. Strong market, bigger checks. Downturn, smaller checks. This is the fundamental difference from a fixed payout: you keep market exposure in both directions.
Fees Keep Running
A common misconception is that fees stop once you annuitize. They don’t. Mortality and expense risk charges continue to be deducted from your sub-account values during the payout phase, typically ranging from about 0.20% to 1.80% annually, assessed daily against the sub-account balances. Administrative and distribution fees for recordkeeping, statements, and service also continue, generally running from 0% to 0.60% annually. These charges reduce the net return of the sub-accounts, which in turn affects whether payments rise or fall against the AIR.
How the Payments Are Taxed
Tax treatment depends on whether the annuity is qualified or non-qualified, meaning whether the money going in was pre-tax or after-tax.
Qualified Annuities
If the annuity is held inside a traditional IRA, 403(b), or similar pre-tax account, every dollar of every payment is taxable as ordinary income. The entire contract value represents money that was never taxed, so there is no basis to recover. The insurer reports the payments on Form 1099-R each year.2Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
Non-Qualified Annuities
If you bought the annuity with after-tax money, each payment is split into a taxable portion (the earnings) and a tax-free portion (return of your original investment). Federal law determines the split through an exclusion ratio: your investment in the contract divided by the total expected return under the contract.3Office of the Law Revision Counsel. 26 US Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The expected return is calculated using IRS life expectancy tables. Once you have recovered your entire basis, every dollar of every later payment becomes fully taxable.4Internal Revenue Service. Publication 575 – Pension and Annuity Income If you die before recovering the full basis, the unrecovered amount can be claimed as a deduction on your final return.
Payments Before Age 59½
Distributions from an annuity before age 59½ generally trigger a 10% additional tax on the taxable portion. Annuitization can sidestep this. Payments that qualify as substantially equal periodic payments made at least annually over your life or life expectancy are exempt from the 10% penalty even if you are under 59½. The catch: if the payments are modified or stopped before the later of five years from the first payment or your reaching age 59½, the IRS retroactively imposes the 10% penalty on all prior distributions, plus interest.3Office of the Law Revision Counsel. 26 US Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Because annuitization is irreversible, this rarely bites, but a period-certain-only option that ends before the five-year window closes can trigger it.
Required Minimum Distributions
If the variable annuity sits inside a qualified account, annuitized payments count toward your RMD obligation for that account. Under the SECURE 2.0 Act, if your annuity payments exceed the RMD calculated on the annuity portion of the account, the excess can be applied toward RMD requirements from other qualified accounts, including the non-annuity portion of the originating IRA.5US Senate Health, Education, Labor and Pensions Committee. SECURE 2.0 Section by Section Before that change, annuity payments could only satisfy the RMD for the annuity itself, which sometimes forced extra distributions from other accounts.
If Medicaid May Be in the Picture
If long-term care costs could push you toward Medicaid eligibility within the next several years, annuitization carries specific legal requirements. Federal law treats the purchase or annuitization of an annuity as a disposal of assets, potentially triggering a Medicaid transfer penalty, unless the annuity is irrevocable and non-assignable, actuarially sound (meaning it pays out within the annuitant’s life expectancy), structured with equal payments and no balloon or deferred payments, and names the state Medicaid agency as the remainder beneficiary.6Office of the Law Revision Counsel. 42 US Code 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets The state can be placed in the second position behind a spouse or minor or disabled child, but it must appear in the first position if no such family member exists or if that family member later disposes of the remainder. Getting this wrong can produce a penalty period during which Medicaid will not cover nursing facility costs. Talk with an elder law attorney before signing.
Starting the Paperwork
Contact your insurance carrier’s service center or your financial advisor to request an annuitization package. The carrier will send election forms requiring you to specify the payout option, name beneficiaries, and provide proof of age for anyone whose life expectancy enters the calculation, typically a driver’s license or birth certificate. Most carriers require the forms to be signed before a witness or notarized given the permanence of the decision. Processing generally takes four to eight weeks before the first payment arrives. The carrier issues a confirmation statement detailing the chosen option, the AIR, your initial payment amount, and the effective date; keep it with your records and your annual Form 1099-R.
Before you sign, compare the annuitization rates your carrier is offering against what a competitive immediate annuity from another insurer would pay. Some carriers offer below-market annuitization rates, and if the gap is significant you may do better taking a lump-sum distribution, paying any applicable taxes and penalties, and buying an immediate annuity elsewhere. The comparison is especially worth running on contracts more than 15 years old, where annuitization terms are sometimes less favorable than today’s market.