How to Convert a Lump Sum to an Annuity

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A lump sum refers to a distribution method used with retirement savings accounts or insurance benefits. When you take a lump-sum distribution, you are taking the entire value of the account out in one distribution. Other options are regular periodic payments or occasional payments, which may be determined the source of the asset. You can take a lump-sum distribution from a qualified retirement plan, such as a 401k or from a non-qualified asset that includes life insurance benefits or a lottery winning. Both of these account structures can convert the lump-sum into an annuity.

1. Establish where the lump sum payment is coming from: a qualified source or non-qualified source. How you convert the lump sum will be affected by this as well as whether the money is received as an inheritance.

2. Determine if you want the annuity to grow or to start an immediate income stream. Growth annuities are called tax-deferred annuities and allow earnings to grow without paying taxes until the money is distributed–similar to a retirement savings plan. Immediate annuities pay a lifetime or period specific income based on the lump sum and guaranteed interest on the assets.

3. Go to an annuity provider. Most banks, brokerage firms and life insurance agencies offer fixed and variable annuities. Meet with a representative to review your annuity options.

4. Open an annuity account that meets you investment or income needs. If the lump sum is from a lottery winning or inheritance, you will open a non-qualified annuity. If the lump sum is coming from a previous employer's retirement plan, open a qualified annuity–if you open a non-qualified annuity, the Internal Revenue Service views the lump sum as 100 percent distributed and taxable whereas if the annuity is qualified, it serves as a rollover.

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Tip

If you are inheriting a lump sum from an annuity or retirement plan, discuss taking distributions over time or opening a beneficiary Individual Retirement Account. This reduces the amount of income tax owed in the year you inherit the money, stretching payments over five years or longer with beneficiary IRAs.

Warning

If the lump sum is coming from your employer retirement account as a rollover, know that 20 percent of the entire account is withheld for federal taxes until the rollover is complete. This means you need to deposit 100 percent of the account into a rollover IRA annuity, finding the missing 20 percent from savings or other sources. Talk to your employer’s plan administrator about doing a direct rollover that avoids sending you the lump sum and sends the money directly to the new custodian IRA annuity. This avoids the 20 percent withholding issue.