When you annuitize a variable annuity, the insurance company ends the accumulation phase of your contract and converts your account value into a stream of periodic payments, usually for life. Your dollar balance becomes a fixed number of “annuity units,” and each payment equals that number multiplied by the current unit value, which rises and falls with the sub-accounts you were invested in. The decision is permanent: you cannot reverse it, you cannot pull out a lump sum later, and the only flexibility left is whatever your chosen payout option builds in.
What Changes Inside the Contract
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 that arrangement. The insurer runs your balance through actuarial tables and issues you a fixed number of annuity units. From that day forward, you own units rather than dollars. The unit count never changes. The value of each unit is recalculated each period based on how the underlying sub-accounts performed.
This is what separates a variable annuity payout from a fixed annuity payout. A fixed annuity sends the same check every month. A variable payout keeps you invested, so your income can grow in strong markets and shrink in weak ones. That market exposure is the point of choosing a variable payout in the first place.
The irreversibility catches many people off guard. Once payments start, you cannot switch payout options, change the guarantee period, or take a lump sum for an emergency. If a $50,000 medical bill lands next year, the annuitized contract cannot help with it. Your only income from the contract is the scheduled payment.
What You Give Up by Annuitizing
Annuitizing typically terminates the living benefit and death benefit riders you may have been paying for during accumulation. A guaranteed minimum death benefit or an enhanced death benefit generally disappears when the payout phase begins. Any death benefit that survives is whatever your settlement option provides, such as remaining period-certain payments to a beneficiary, not the separate rider itself.
You also lose liquidity entirely. During accumulation, most contracts allow annual withdrawals of up to 10% of value without surrender charges. That option vanishes at annuitization.
Before committing, check whether your contract offers a guaranteed lifetime withdrawal benefit (GLWB) rider. A GLWB pays lifetime income while letting you keep access to the remaining account value, and any balance at death passes to your beneficiaries. The income is usually lower than full annuitization would produce, and the rider carries an annual fee, but the flexibility can be worth the tradeoff. Systematic withdrawals with no guarantee are another route, though they carry the risk of outliving the money.
Choosing a Payout Option
The payout option you select determines how long payments last, how large they are, and what happens to the money if you die. It’s the most consequential choice in the process, and it cannot be changed afterward.
Life Only
Life only produces the highest periodic payment because the insurer’s obligation ends the moment you die. Nothing passes to heirs. If you annuitize $500,000 and die six months later, the balance stays with the insurer. This option fits someone with no dependents or with other assets earmarked for heirs. It fits poorly if a spouse relies on the income.
Life With Period Certain
This option pays for life but guarantees a minimum number of years, commonly 10, 15, or 20. Die within the guarantee window and your beneficiary receives the remaining payments until the period ends. Outlive it and payments continue for your lifetime with nothing left over. Longer guarantees mean smaller checks, because the insurer is taking on more risk.
Joint and Survivor
Built for couples, this option pays until both annuitants have died. The initial payment is lower than a single-life payout because the insurer is covering two lifetimes. The survivor percentage you choose sets the payment after the first death: 100% keeps the check the same, 50% 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
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 sends the remainder as a lump sum. An installment refund continues periodic payments to the beneficiary until the full investment has been returned. The installment version usually produces a slightly higher payment during your lifetime because the insurer pays out any 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’s not a lifetime option. If you outlive the term, payments stop. Any remaining payments during the term go to your beneficiary if you die. There is no longevity protection here, so you bear the risk of outliving the income yourself.
How the First Payment Is Calculated
Three factors set your initial payment: your accumulated contract value, the mortality factor for your age and 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 AIR is a benchmark return written into your contract. Think of it as the breakeven line. The insurer calculates your first payment as if the sub-accounts will earn exactly the AIR going forward. Every subsequent payment then depends on how actual returns compare to that benchmark. Beat the AIR in a given period and your next payment rises. Fall short and it drops. Hit it exactly and the payment stays flat. A lower AIR produces a smaller first check but an easier hurdle to clear, so increases are more frequent over time. A higher AIR gives you a bigger first check and a tougher hurdle afterward. AIRs typically fall in a conservative range, often between 3% and 5%.
Why Payments Move
Your unit count is locked at annuitization. What changes is the dollar value of each unit, recalculated each period based on sub-account performance relative to the AIR. Strong markets push unit values up and your checks with them. Downturns do the reverse.
Fees Do Not Stop at Annuitization
A common assumption is that contract fees end once income begins. They don’t. Mortality and expense risk charges continue to come out of your sub-account values during the payout phase, typically running from about 0.20% to 1.80% annually and assessed daily. Administrative and distribution fees continue as well, generally ranging from 0% to 0.60% annually. These charges reduce net sub-account returns, which is what determines whether your payments grow or shrink relative to the AIR.
How Payments Are Taxed
Tax treatment depends on whether the annuity is qualified or non-qualified, which is another way of asking whether the money going in was pre-tax or after-tax.
Qualified Annuities
If the annuity sits inside a traditional IRA, 403(b), or similar pre-tax account, every dollar of every payment is taxable as ordinary income. There is no basis to recover. Payments are reported to you each year on Form 1099-R.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 splits into a taxable earnings portion and a tax-free return-of-principal portion. Federal law sets the split using an exclusion ratio: your investment in the contract divided by the total expected return, with the expected return based on IRS life expectancy tables.3Office of the Law Revision Counsel. 26 US Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Once you have recovered your entire basis, every subsequent dollar 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.
The 10% Early Distribution Penalty
Distributions before age 59½ generally trigger an extra 10% 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 penalty even under 59½. There is a trap: if the payments are modified or stopped before the later of five years from the first payment or the date you reach 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, modification usually isn’t a risk, but a period-certain-only option that ends before the five-year window closes could trigger the problem.
RMDs on Qualified Contracts
If the contract is inside a qualified account, annuitized payments count toward your required minimum distribution for that account. Under the SECURE 2.0 Act, if the annuity payments exceed the RMD calculated on the annuity portion, the excess can apply 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
Medicaid Planning Boundaries
If long-term care and Medicaid eligibility are on the horizon, annuitization carries specific rules. Federal law treats the purchase or annuitization of an annuity as a disposal of assets, which can trigger a Medicaid transfer penalty, unless the annuity is irrevocable and non-assignable, actuarially sound so that 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 remainder beneficiary.6Office of the Law Revision Counsel. 42 US Code 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets The state can sit in the second remainder position behind a spouse or a minor or disabled child, but it must be 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 won’t cover nursing facility costs. Talk to an elder law attorney before annuitizing if long-term care is a realistic possibility.
How to Start the Payments
Starting annuitization takes paperwork and time. Contact the carrier’s service center or your financial advisor and request an annuitization package. The carrier will send election forms asking you to specify your payout option, name beneficiaries, and provide proof of age for anyone whose life expectancy factors into the calculation, typically a driver’s license or birth certificate.
Most carriers require the election forms to be signed before a witness or notarized, given how permanent the decision is. Processing generally takes four to eight weeks before the first payment arrives. The carrier issues a confirmation statement showing your chosen option, the AIR, your initial payment amount, and the effective date. Keep it. It functions as your final contract for the income stream, and you’ll need it alongside your annual Form 1099-R at tax time.