(b)lines Ask the Experts – Difference Between Investment in Annuity and Annuity Distribution

“I have just been contacted by an employee who is retiring who wishes to initiate the process of ‘annuitizing’ her benefit when she retires. I am relatively new to working with our 403(b) plan and am confused, as our 403(b) plan only offers annuity investments. Isn’t an annuity automatic?”

Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

The Experts are quite happy that you posed this question, as you are addressing a common misconception among plan sponsors with annuity benefits in their plans. Although they sound the same, plan investments in annuities and the decision of a participant as to whether or not to receive an annuity form of distribution are two separate and distinct concepts.

As pointed out in a previous Ask the Experts column, an annuity contract refers to a type of investment that can be offered within a 403(b) plan. An annuity is an insurance product, where the insurer provides a contractual promise to the contract holder (plan participant) to pay a specified amount at regular intervals over a specified period of time, which may be for the participant’s life or the joint life of the participant and a designated beneficiary, similar to a defined benefit plan (for example, X dollars a month over the participant’s lifetime). The insurance company is insuring that the participant will be paid such a benefit, which is why it is an insurance product.

However, just because your 403(b) plan offers annuities as an investment (and, in your case, as the only form of investment) does NOT mean that all of your plan participants must receive an annuity benefit when they are eligible to receive a distribution from the plan. Thus, an annuity distribution is not “automatic” as you state. Annuity investments (which might be similar to mutual funds, known as “variable annuities,” or might have fixed returns, such as “traditional annuities”) do not have to be distributed as annuities, and the participant can elect any alternate form of distribution that is permitted under the plan, such as a lump-sum, partial withdrawals, or installment payments. In fact, many participants indeed choose one of these options instead of purchasing an annuity payable over the life of the participant or the joint lives of a participant and designated beneficiary. But, some participants prefer to make sure they do not outlive their benefits by purchasing such annuities and shifting that risk to the insurance company.

In order for your participant to “annuitize” her benefit (note that “annuitize” is just another way of saying that she wishes to receive such an annuity distribution), she should contact the plan’s recordkeeper to obtain the appropriate paperwork to elect an annuity form of distribution. Note that, in some cases, spousal consent may be required.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.