Split-Funded Annuity

What Is a Split-Funded Annuity?

A split-funded annuity is a type of annuity that uses a portion of the principal to fund immediate monthly payments and then saves the remaining portion to fund a deferred annuity.

How a Split-Funded Annuity Works

An immediate payment annuity converts a lump sum into a stream of fixed payments right away. In contrast, a deferred annuity (sometimes called a delayed annuity) grows the initial lump sum for a period of time — often several years — before the annuitization phase is triggered and payments begin.

Using a split-funded annuity provides both products, meaning that individuals do not have to wait for the annuity to reach the payout phase because the stream of income begins immediately. At the same time, the annuity's remaining balance compounds tax-deferred.

When Split-Funded Annuities Make Sense

This type of annuity may be most appealing to people nearing retirement age or for those who are already retired.

For example, someone with a $3,000,000 nest egg could divide the amount between an immediate annuity with a 10-year term and a deferred annuity with the same term. Assuming a 5% annual return, this person could collect monthly payments for 10 years, and at the end expect the account to be worth about what it was when they started.

In order to structure the annuity so it grows back into its original principal, the split may be uneven, with more directed to the deferred portion of the annuity. 

Sticking to a Budget

These instruments may also be a good choice for people who are not adept at handling money. The funds in the annuity are locked away so it's easier to stick to a budget and know the monthly stream of payments will be there.

One criticism of annuities is that they are illiquid. Deposits into annuity contracts are typically locked up for a period of time, known as the surrender period, where the annuitant would incur a penalty if all or part of that money were touched. These surrender periods can last anywhere from six to eight years, depending on the particular product. Surrender fees can start out at 10% or more, and the penalty typically declines annually over the surrender period.

Annuities are appropriate financial products for individuals seeking stable, guaranteed retirement income. Because the lump sum put into the annuity is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs. Annuity holders cannot outlive their income stream, which hedges longevity risk. So long as the purchaser understands that they are trading a liquid lump sum for a guaranteed series of cash flows, the product can be appropriate.