Annuitization in Annuities: Turning Your Savings into Lifetime Retirement Income

You may have come across the term “annuitization” many times in my detailed annuities review as one of the payment options. But what is it exactly, and how is it calculated? If you’re approaching retirement (especially if you’re 50 or older), annuitization might sound complex. In reality, it’s a simple concept at heart. This article will break down annuitization in plain language – explaining what it means, how it works, how your payments are determined, how it applies to different annuity types, and the pros and cons. We’ll even walk through a realistic example of a 60-year-old choosing to annuitize a deferred annuity. Let’s dive in!

What Is Annuitization?

Annuitization basically means turning the money in your annuity into a steady stream of income payments​. Think of it as converting your retirement nest egg into a pension-like paycheck that arrives regularly. When you annuitize an annuity, you enter the “payout phase” of your contract – the insurance company takes the value you’ve accumulated and starts sending it back to you as monthly (or quarterly, etc.) payments for a set period or for the rest of your life. In simple terms, you’re exchanging your lump sum savings for a guaranteed income stream.

An annuity that has been annuitized will pay you a series of checks, much like a salary in retirement. For example, a Single Premium Immediate Annuity (SPIA) – which is an annuity designed to start payments immediately – will pay the policyholder a fixed amount each month for life. If it’s a Joint and Survivor annuity, it will pay income over the lifetime of both spouses. The whole idea is to “not outlive your money” – annuitization reduces the risk that you’ll run out of funds by providing lifetime payments.

It’s important to note that annuitization is generally a one-time, irreversible event. Once you convert that lump sum into an income stream, you typically cannot change your mind and take the lump sum back – the deal is set with the insurer. That’s why understanding it is so important before you make the choice. Now, let’s look at how the annuitization process actually works.

How Does Annuitization Work?

Annuitization might sound technical, but we can break down the process into a few clear steps. Here’s what happens when you annuitize an annuity:

Reaching the Payout Start Date: If you have a deferred annuity, your contract will specify when you can start annuitization (often this can be after a certain number of years or after a certain age, commonly 59½ or later). You don’t have to annuitize at that exact date – rather, it becomes an available option. With an immediate annuity, this step happens right away: you purchase the annuity and it’s designed to start paying income almost immediately (typically within 12 months). In short, you annuitize when you’re ready to start receiving regular income from your annuity.

Choosing a Payout Option: Next, you’ll choose how you want to receive the payments. Annuities offer several payout options:

Lifetime (Life Only): Income for the rest of your life. This usually provides the highest monthly payment, since it’s based solely on your life expectancy and nothing is left for beneficiaries after you die.

Joint and Survivor: Lifetime income for you and another person (e.g. your spouse). Payments continue until the second person (survivor) dies. Because the payout is guaranteed for two lifetimes, the monthly amount is lower than a single life payout.

Period Certain: Income for a fixed period (10 years, 20 years, etc.) regardless of life or death. If you die during that period, payments continue to your beneficiary until the period ends. If you outlive the period, payments stop at the end of the term. This ensures a minimum payout period but does not guarantee lifelong income.

Life with Period Certain: A combination of the above – for example, payments for life, but with a guarantee that if you die early (say, within the first 10 years), your beneficiary receives the remaining payments for that 10-year minimum. Because the insurer is guaranteeing more (either your whole life or at least a certain number of years), the monthly payments will be lower than a straight life-only annuity.

(There are other variants, too, like refund options, but the above are the most common for simplicity.)

Choosing the payout option is important because it affects how much you get each month and what happens to any remaining value if you pass away. We’ll discuss the trade-offs soon.

Calculation of Payments: Once you’ve chosen the payout type, the insurance company calculates your payment amount. They use annuitization rates (actuarial formulas) that factor in:

Your annuity’s accumulated value (the amount of money you’re converting into income).

Your age and life expectancy (or joint life expectancies, if it’s joint). This helps determine how long the payments might need to last.

Interest rates at the time of annuitization (the insurer uses a rate to figure out how your lump sum can be paid out over time with interest). Higher interest rates allow higher payouts, all else equal.

The payout option you selected (lifelong payments just for you, versus guarantees for beneficiaries, etc., as noted above).

Using these factors, the insurer “converts” your lump sum into a series of periodic payments. In industry terms, they may convert your account value into something called “annuity units” if it’s a variable annuity, or simply apply a rate per $1,000 to calculate a payment. The key idea is that the company is determining a payment that is actuarially fair given your expected longevity and current interest conditions. In short, they ask: given this person’s age and the amount of money they have, how much can we pay them every month so that their money (plus interest) lasts for the duration of the contract? The insurance company’s promise is that if you live longer than expected, they still have to keep paying you – even if payments eventually exceed your original principal. (This is the longevity insurance aspect of annuities.)

Converting to Income (Irrevocable Step): Once the calculation is set, your annuity is officially annuitized. The lump sum in your account is essentially exchanged for the promise of those payments. This means you no longer have access to that money as a single chunk. You can’t withdraw it in a lump or leave it invested – it’s now committed to the payout schedule. In other words, you gave the insurance company your pot of money, and in return they give you a contract to pay you periodically. This step is usually irrevocable; you’re “locked in” to the payment plan.

Receiving Payments: Finally, you begin receiving your income checks at the stated frequency (monthly is most common). These payments will continue as per your chosen option (for life, joint lives, fixed period, etc.). You can now enjoy a predictable income stream in retirement. For many retirees, this steady cash flow can provide peace of mind and help cover regular expenses.

That’s the process in a nutshell. It may help to remember that annuitization marks the transition from the “accumulation phase” (when you were saving money in the annuity) to the “payout phase” (when you’re drawing money out). It’s like flipping a switch: before annuitization, your goal was growing or protecting your savings; after annuitization, the goal is receiving income.

How Are Annuity Payments Calculated?

You might wonder how exactly the insurance company decides to pay you, say, $500 per month versus $600 per month. While you don’t need to do the math yourself, it’s good to know the key factors that determine your payout:

Your Account Value: Simply, the more money you annuitize, the higher your payment. Annuitizing $200,000 will yield roughly double the income of annuitizing $100,000 (before considering any other differences).

Your Age (and Gender): Age is crucial because it relates to life expectancy. If you annuitize at an older age, the insurer doesn’t expect to pay you for as many years, so each payment can be larger. Conversely, starting younger means the payments are spread over more years, so each payment is smaller. For example, one analysis found that a $100,000 immediate annuity purchased at age 60 pays about $508 per month for life, while the same $100,000 annuitized at age 65 pays about $561 per month – and at age 70 it pays roughly $613 per month. The older you are when income starts, the higher the monthly payout from a given lump sum. (Gender can also play a role, since women on average live longer than men – annuity payouts may be a bit lower for a female annuitant of the same age and circumstances, reflecting that the insurer expects to pay for more years. Many insurers use unisex tables for certain contracts, but it’s something to be aware of.)

Interest Rates / Annuitization Rates: Interest rates in the economy influence annuity payout rates. The insurance company invests the money you annuitize, so prevailing interest rates help determine how much they can earn on that money to fund your payments. When interest rates are higher, new annuities generally can pay out more. In fact, as of 2024, income annuity payouts were at their highest levels in over a decade thanks to rising interest rates. (This means someone annuitizing in 2025 might secure a better monthly payout than someone who did so in, say, 2020 when rates were very low.) Conversely, in a low-rate environment, payouts are lower. Insurers publish annuitization tables or use actuarial formulas that combine interest assumptions with mortality (life expectancy) to calculate your payment. You don’t see all those details, but you see the end result in your quote or contract.

Payout Option Chosen: As described earlier, the type of payout affects the amount. If you choose a life-only annuity, the calculation is based only on your life expectancy – which maximizes the payment to you, but means nothing is left for heirs when you die. If you add guarantees like a period certain or a cash refund or a survivor benefit for a spouse, the insurer factors in those extra promises. Because they might have to pay out for longer (to a spouse or at least X number of years), the monthly amount they can afford to pay you initially will be a bit less. For example, a life-only annuity will pay more per month than a “life with 10-year period certain” annuity of the same amount, all else equal, because the latter is guaranteeing at least 10 years of payments even if you pass away​. Similarly, a joint-life annuity for a couple might pay somewhat less each month than two separate single-life annuities, since the joint annuity is covering the longer of two lifetimes. In summary: the more guarantees to ensure payments continue (to you or someone else), the lower the initial payment will be, compared to a straight life-only payout.

All these factors are baked into the annuitization calculation. The insurance company’s actuarial department does the number-crunching, and you are typically presented with a payout quote or illustration. The math itself involves present value calculations and life expectancy probabilities, but you do not need to crunch those numbers yourself. It’s similar to how a mortgage works in reverse – instead of you making payments to a bank, you’ve given a lump sum to an insurer and they “pay it back” to you with interest over time.

To keep things simple: the insurer uses your contract value, your life expectancy, and an interest rate factor to compute a level payment that will exhaust the funds over the expected period (with the insurer taking the risk of payout if you live longer). If you live exactly as long as the actuarial tables predict, the idea is you will have received your entire principal plus interest by the end of your life or the period. If you live longer, the insurer pays out more than you put in (a win for you). If you die sooner, the insurer keeps the leftover (unless you had a guarantee in place). That’s the trade-off inherent in annuitization.

Annuitization in Different Types of Annuities

There isn’t just one kind of annuity – and the role of annuitization can differ slightly depending on the type you have. Let’s look at how annuitization applies to a few common categories:

Immediate Annuities: An immediate annuity is essentially annuitization from day one. You pay a single premium and the income payouts begin within 12 months (often immediately next month). There is no separate accumulation phase. For example, you might hand an insurer $100,000 at age 65 and they immediately convert that into a promise of monthly income for life (this is a classic pension-like annuity). With an immediate annuity, you have already annuitized at purchase – so the concepts of annuitization we discussed (like choosing payout options and calculating payments) are applied at the very start. Immediate annuities are straightforward: you know your payment and it begins right away. They are often used by retirees who want to turn a chunk of savings into a guaranteed paycheck.

Deferred Annuities: A deferred annuity has two phases: an accumulation (or deferral) phase when your money grows, and the payout phase which can start later. Many people purchase a deferred annuity years before retirement – for example, at age 50 – and let it grow tax-deferred. When you reach the age you want income (say 60 or 65 or 70), you have the option to annuitize the contract and start payments. Some deferred annuities are specifically deferred income annuities (DIAs), where you lock in the annuitization terms upfront, but you still don’t get income until some future date (e.g. “I invest now at 55 to get a guaranteed income starting at 65”). Others are more flexible, like deferred variable or fixed annuities where annuitization is just one of several options you can choose down the road. In a deferred annuity, annuitization is not mandatory (many contracts never annuitize – owners might take partial withdrawals or roll over the funds). But if you decide to annuitize, the process is as described: you tell the insurer you want to convert the accumulated value into an income stream. 

Key point: Annuitization of a deferred annuity is a choice you make when you want to start lifetime (or fixed-period) income. It’s one way to use the money. Some contracts might have a latest possible annuitization age (for example, by 85 or 90 you must start, to comply with contract rules), but generally you have flexibility on if and when to annuitize.

Fixed Annuities: A fixed annuity means during the accumulation phase, your money earns a fixed guaranteed rate of interest, and in the payout phase, the payments to you are usually fixed (stable) as well. If you annuitize a fixed annuity, the income amount is determined based on guaranteed interest assumptions or current rate offerings. The resulting payments will not fluctuate – you’ll get a predictable, level amount each period. This can be great for budgeting since you know exactly what you’ll get. However, keep in mind a fixed payment also means inflation can erode its purchasing power over time (more on that in pros/cons). Many fixed annuities come with tables in the contract that tell you the minimum income you’d get if you annuitize at certain ages with certain options, so you have some idea in advance. Fixed annuities provide certainty: the insurance company bears the interest and market risk. By annuitizing a fixed annuity, you essentially lock in a guaranteed payout backed by the insurer. (There are also fixed indexed annuities – a hybrid where growth is linked to a market index with a guaranteed minimum – but upon annuitization they often behave like a fixed annuity in terms of providing a stable payout, unless a specific inflation adjustment feature was included.)

Variable Annuities: A variable annuity allows your money to be invested in subaccounts (like mutual funds) during accumulation, so the value can go up and down with the market. If you choose to annuitize a variable annuity, you usually have two choices: a fixed payout or a variable payout. A fixed payout from a variable annuity means the insurer converts your account to a stable dollar payment (often by moving your value into a fixed account at annuitization) – effectively turning it into a fixed immediate annuity at that point. Variable annuitization, on the other hand, means the payments themselves will vary over time with the performance of the underlying investments​. You would be exchanging your account value for a number of “annuity units” (not to get too technical) and your monthly paycheck can rise or fall depending on how the investments perform relative to an assumed interest rate. The idea is that if the market does well, your payments can increase (helping with inflation); if it does poorly, payments can decrease. Variable annuitization carries more risk (your income isn’t fixed) but also the potential for growth in income. It’s less common for people to annuitize with variable payments unless they specifically want that inflation hedge and are okay with fluctuating income. Many modern variable annuities actually offer riders (like guaranteed withdrawal benefits) as an alternative to annuitization, precisely because traditional annuitization can be complex or unattractive to some. But it’s still an option: you can annuitize a variable annuity contract and decide whether you want a fixed payment or one that varies with market performance. Just remember, once you annuitize, the fees and features of the accumulation phase (e.g. mortality and expense charges, riders) often end, and it becomes all about the payout.

In summary, annuitization is a concept that applies to all annuities, but when and how it happens differs:

With an immediate annuity, annuitization is immediate (built into the product).

With a deferred annuity, annuitization is optional and timing is up to you (until a certain age).

In a fixed annuity, annuitization yields fixed payments.

In a fixed indexed annuity, accumulation is linked to a market index with a guaranteed minimum value, but upon annuitization, they often behave like a fixed annuity in terms of providing a stable payout.

In a variable annuity, annuitization can yield variable payments (or you can choose to have fixed payments at that time).

No matter the type, the core idea remains: you trade the lump sum for a series of payments. Now, let’s weigh the general pros and cons of annuitizing your annuity.

How Is Annuitization Different from a GLWB Rider?

You may have heard of something called a Guaranteed Lifetime Withdrawal Benefit (GLWB) rider and wondered how it's different from annuitization. Both options can give you lifetime income, but they work differently.

Annuitization converts your lump-sum annuity value into regular payments, typically irrevocably. Once annuitized, you no longer have access to the principal. Essentially, you're giving up the lump sum in exchange for guaranteed, regular payments.

On the other hand, a GLWB rider offers guaranteed lifetime income without forcing you to give up control over your principal. With a GLWB rider, your annuity remains invested, and you can still access your remaining account value (though withdrawals beyond your guaranteed amount may reduce your future payments). Additionally, if you pass away and still have money left in the account, it can generally be passed to your beneficiaries.

However, it's important to know that GLWB riders often come with higher fees, which can significantly impact your annuity’s growth potential and the total benefits you ultimately receive. These fees vary widely depending on the insurer and specific terms of your contract, making it essential to carefully review costs before selecting this option.

Given their complexity and the important role fees play, GLWB riders deserve a dedicated, detailed explanation of their own—so I'll cover them thoroughly in a separate article. For now, just know they offer more flexibility than annuitization but typically come at a cost.

In simple terms:

Annuitization: You permanently trade your lump sum for lifetime payments (giving up flexibility).

GLWB Rider: You keep flexibility and access to your principal while still receiving guaranteed lifetime income, but typically pay higher fees.

Choosing between annuitization and a GLWB rider depends on your need for flexibility, legacy planning, comfort with giving up access to your funds, and sensitivity to fees.

Pros and Cons of Annuitization

Like any financial decision, annuitization has its advantages and disadvantages. Here are some key pros and cons to consider:

Pros of Annuitization:

Guaranteed Lifetime Income: This is the big one. By annuitizing with a lifetime payout, you secure an income you cannot outlive – even if you live to 100+. The insurance company bears the longevity risk. This provides tremendous peace of mind that no matter how long you live, you’ll have a baseline income coming in. It’s effectively like creating your own pension. In an era when fewer people have employer pensions, this is a way to create a personal pension.

Predictable, Steady Payments: Especially with fixed annuity payouts, you get a stable amount every month or every year. This makes budgeting in retirement much easier. You know your “paycheck” amount. It’s not subject to stock market swings or interest rate changes once started (unless you chose a variable payout). This reliability can reduce stress around managing investments in retirement.

Simplicity and Hands-Off Management: After annuitization, you don’t have to actively manage that chunk of money anymore. There’s no need to worry about investment decisions, rebalancing portfolios, or withdrawing the right amount each year. The insurance company handles the heavy lifting. You just receive your payments. For retirees who don’t want the hassle of managing a large portfolio, this is attractive.

Higher Payout for Longer Life (Mortality Credits): Annuities have a unique benefit often called mortality credits – basically, the premiums of those who die earlier help fund the payments for those who live longer. If you expect to live longer than average (perhaps you’re healthy or have longevity in your family), annuitization can provide more total income over your lifetime than you’d likely get by drawing down the same lump sum yourself cautiously. In other words, it can be a good deal for those who beat the averages, since the insurance pool shares the risk.
Optional Benefits for Spouse/Heirs: If leaving something behind is important, you can choose options like period certain or joint life so that your spouse continues to receive income if you die first, or your children get payments for a guaranteed period. While these adjustments lower your payment, they can provide peace of mind that annuitization doesn’t have to mean “nothing for my family” (it’s all about how you set it up).
Tax Benefits for Non-Qualified Annuities: If your annuity was funded with after-tax dollars (a non-qualified annuity), each payment after annuitization is typically split into a non-taxable return of principal and a taxable earnings portion. This spreads out the tax burden. Only the interest portion of each payment is taxed as ordinary income, and part of your payment is tax-free until you’ve recovered your principal. (By contrast, taking withdrawals from an annuity typically uses interest-out-first taxation where earnings come out and are taxed first) This can be an advantageous tax treatment, resulting in a level of tax-deferral extending into the payout phase.

Cons of Annuitization:

Loss of Liquidity and Control: When you annuitize, you generally give up access to the lump sum value of your annuity. You can’t decide next year “Actually, I need $50,000 out for a home repair” – the money is now locked into the payment stream. This loss of flexibility is a major drawback. In an emergency or if your needs change, you can’t tap that principal (beyond the scheduled payments). Essentially, you’ve ceded control of that chunk of your savings to the insurance company in exchange for the guarantee. So you need to be sure you won’t need that lump sum for other purposes.
Irrevocability: Along with losing control, annuitization is typically irrevocable. Once you start, you usually can’t undo it. There’s no “off switch” if you change your mind or if circumstances change. That’s why it’s important to be confident in your decision and to annuitize only the portion of your assets that you’re comfortable setting aside for steady income.
Inflation Risk (for Fixed Payouts): A fixed monthly payment might be comfortable now, but over a long retirement, inflation will erode its buying power. For example, $2,000 per month today won’t buy as much 20 years from now. Standard annuitization usually does not include cost-of-living increases (unless you specifically purchased an inflation-indexed annuity). While insurers do offer inflation-adjusted annuities, they start with significantly lower initial payments, and many people find those trade-offs expensive. Most retirees who annuitize choose a level payment, which means you must be mindful that its real value declines over time. You might use other investments or income sources to handle inflation. But lack of growth on that income is a concern – once annuitized, that money isn’t invested for further growth (unless you chose a variable payout), so it won’t keep pace with rising costs.
Potentially Less to Leave Heirs: If leaving a financial legacy is a priority, annuitization can be problematic, especially if you choose a life-only payout. With a pure life annuity, when you die, payments stop – no matter how soon that is. It is possible (though not pleasant to think about) that you could invest a large sum in an annuity and pass away only a few years later, thereby receiving only a small portion of what you paid in, and your heirs would get nothing (unless you had a guaranteed period or refund feature). The flip side is if you live a very long time, you might get far more than you put in – but the risk of early death means the insurance company keeps the unused funds. This “use it or lose it” aspect is a big mental hurdle for some. It can be mitigated by choosing options that guarantee payments for a minimum time or refunds, but again those reduce the payments. In any case, annuitizing usually means you’re prioritizing your income security over leaving a large inheritance.
Opportunity Cost / Lower Flexibility in Financial Planning: Once your money is annuitized, you might miss out on other investment opportunities. For example, if stock markets boom or if you find a real estate investment, you can’t redirect your annuity money to those because it’s tied up. Some people prefer to keep their investments available to potentially earn higher returns or to adapt to changing plans. Annuitization can be seen as conservative – it sacrifices upside potential for certainty. If the annuity’s internal rate of return (based on your payments and how long you live) ends up being modest (say you don’t live exceptionally long), you might have been better off financially by not annuitizing. There’s a bit of a gamble either way, but it’s something to weigh.
Complexity and Fees (Depending on Product): The concept of annuitization is straightforward, but annuity products themselves can be complicated. If you have a variable annuity with riders, understanding how and when annuitization fits in can be dizzying. Some annuities might have surrender charges if you annuitize “too early” (though many waive them if you annuitize after a certain number of years – it depends on the contract). Also, if you purchased an annuity with high fees during accumulation (like certain variable annuities), those fees might have eaten into returns, meaning your account value (and thus your income) could be less than if you had invested elsewhere. The cost structure and fine print can be a downside, though once annuitized, usually many of those fees are no longer directly charged. Still, it’s important to understand the product. Always make sure you read the annuity contract or have it reviewed so you know what you’re getting into, and consider getting a second opinion from a financial advisor if an annuity is presented to you – sales presentations might emphasize best-case scenarios and gloss over downsides.

In light of these pros and cons, a common approach is to annuitize part of your retirement funds – enough to cover your basic living expenses (when combined with Social Security and any pensions), so that those needs are met for life. Meanwhile, you keep other assets in more liquid or growth-oriented investments to handle emergencies, legacy goals, or inflation. That way, you get the security of guaranteed income while retaining some flexibility.

Whether annuitization is right for you will depend on your personal situation – your health, need for steady income, other sources of funds, desire for liquidity, and tolerance for the trade-offs. It’s not an all-or-nothing decision; you might annuitize a portion of an annuity or one annuity but not another. Next, let’s walk through a realistic example to see annuitization in action.

Example: Annuitizing a Deferred Annuity at Age 60

Imagine you are 60 years old and you own a deferred annuity that you’ve been contributing to or that has been growing for a while. Let’s say your annuity’s account value is $100,000 at this point (we’ll use a round number for simplicity). You’re considering turning this into a lifetime income stream to help fund your retirement. Here’s how that might play out: