You might not have a large sum of money that you don't know what to do with right now, but that could change in the future. You might receive a lump-sum pension payment when you retire or as a result of a legal settlement. One investment vehicle that allows you to receive an immediate income while still setting money aside for a rainy day is a split annuity.
An annuity is an investment vehicle typically issued by life insurance companies. You send money to the insurance company in regular installments and your money earns interest on a tax-deferred basis. At a designated time, such as when you retire, the insurance company makes payments to you at regular intervals. The size of your installment payment is based on your age and the amount of the accumulated fund.
Split Annuity Concept
The split annuity combines two different types of annuities: the deferred annuity, where your money remains invested for a specified period of time; and the immediate annuity, which allows you to begin to receive payments right away. A split annuity is typically used when an investor has a large sum of money and wants to receive an immediate income while still having money set aside for a future investment goal.
Suppose you have $100,000 in a bank certificate of deposit about to mature, and you want to receive an income while keeping a portion invested. With a split annuity, you could put $50,000 into an immediate annuity that will pay you a regular monthly income. You would put the other $50,000 into a deferred annuity that would continue to earn tax-deferred interest. This process allows you to receive an income while still having money set aside for the future.
Split annuities aren't only used as part of a retirement plan. They are often used in structured settlements in which an individual comes into a large sum of money as the result of a personal injury award. They can also be used for tax-benefit purposes where the investor wishes to defer paying taxes on a large sum of money. Another use occurs when the investors wants a regular income for a specific purpose, such as covering a monthly mortgage payment, while still preserving a portion of the principal.