An annuity is a contract with an insurance company that takes the funds you have built up for retirement and makes payments to you based on a distribution method of your choice.
There are four annuity distribution methods:
A single life annuity makes payments to you for the remainder of your lifetime.A joint life annuity makes payments to you and your beneficiary for the remainder of your lifetime or the lifetime of your beneficiary—whichever is longer.A term certain annuity makes payments for a specific number of years.A life annuity with term certain makes payments to you for the remainder of your lifetime; or, if you die before a specific term such as ten years, payments continue to your heirs until the end of the term.
To determine your required annual minimum distribution, you may simply divide your retirement account balance by a single or joint life expectancy factor. You can use a life expectancy table such as those found in IRS Publication 590. For example, here is a small segment of an IRS life expectancy table:
You may choose to recalculate your required minimum distribution annually. If you recalculate, each year's required minimum distribution will be based on your life expectancy that year. If you choose not to recalculate this figure annually, you simply subtract 1 from your life expectancy every year following the first year you begin receiving distributions. Recalculation generally lowers your payments, because when you live another year, your life expectancy increases.
You also may determine your required minimum distribution through amortization, which is another way to liquidate your assets through periodic payments containing both interest and principal. (This is also the method you may have used to pay off a home mortgage loan.) Amortization involves choosing a reasonable interest rate—often in the 5–10 percent range—and prorating the account balance across a fixed period using the rate and life expectancy tables. You can do the computation using the financial calculator built into many spreadsheet programs or available at various financial Websites.
Which distribution plan you choose can also affect your estate planning and the taxes your heirs will pay, to say nothing of the amount you have to live on when you retire. Be sure you understand your options before you sign your annuity contract.