Life insurance just sounds like a misnomer, since you have to die before your beneficiaries can collect. An annuity, on the other hand, is a kind of life insurance contract that pays a regular stream of income for life while you're still alive. Life insurance, including annuities, is one of the few investments you can't hold in your individual retirement account, but you can get similar benefits by annuitizing your IRA.
Income for Life
Your may build up a tidy retirement nest egg in your IRA but still worry about outliving your resources. Annuitizing your IRA eliminates that worry. The Internal Revenue Service let's you set up a withdrawal plan that pays your distributions in a series of substantially equal payments based on your life expectancy. You can even opt to have your IRA assets paid out over the lives of you and your spouse. With an annuitized IRA, you never have to worry about outliving your money.
If you withdraw money from your traditional IRA before you hit age 59 1/2 you may get tagged with 10 percent early distribution penalty, but there are exceptions to that rule. The IRS waives the penalty if you set up regular distributions through an approved method such as the required minimum distribution method, fixed amortization method or fixed annuitization method. There's no rule that says you have to wait any particular length of time before you start taking withdrawals from your IRA. You could fund your IRA today and annuitize it tomorrow if you want, but the longer you leave your money in your IRA, the more time it has to grow.
The regular income stream from your annuitized IRA continues for life, but you don't have to spend it. If the income exceeds your needs, you can invest it elsewhere, save it or give it away. You're allowed to have multiple IRAs, and there's no rule that says you have to annuitize all of your accounts or even all of the money in a single account. You might use one account to generate a monthly paycheck, while leaving funds in another account to continue growing tax-deferred.
When you annuitize your IRA, you're not just living off the earnings. You're drawing on a combination of the earnings and the principal, based on how long the insurance company expects you to live. You're gambling that you'll beat the odds and outlive the company's life-expectancy chart. As long as you're alive, the annuity keeps on paying. Once you kick the bucket, whatever's left in your annuity goes to the insurance company. If you set up the payout to include yourself and your spouse, you may get a longer payout period based on the life expectancy of whoever is younger, but your distributions will be smaller. The money is still gone once both of you die, leaving no inheritance for your beneficiaries.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.