by Aidan Kang, CFA
Senior Writer
UPDATED: October 13, 2022

If you’re planning to get a loan, having a collateral is usually a plus point. A collateral is a guarantee that you provide the lender so that if you default on the loan, they can come after the collateral to pay off your debts.

It is very common to use your house as a loan collateral and if you’re unable to pay, the lender can repossess your house. Another common type of collateral is your vehicle, which is often used when getting car title loans. But have you ever heard of using your annuity as a collateral when getting a loan? Is this even possible?

The answer is yes. You can use your annuity as a collateral, however, this will depend on the type of annuity you have. Not all annuity plans can be used as a collateral for a loan.

In this article, we will discuss what annuity is and the different types of annuities which could affect your ability to use them as collateral. We will also talk about what annuity loans are and the advantages of getting one.

What Is An Annuity?

Since you are interested to know whether an annuity can be used as a collateral for a loan, you may already be familiar with annuities. However, so we can all be on the same page, we will briefly discuss what an annuity is and how it is different from other investment products.

An annuity can be defined as a type of investment that you can get from an insurance company that will provide you with periodic payments with interest in return for your initial investment. The investment can be a lump sum amount that you pay once or it can also be in installments (like from your payroll).

To put it more simply, an annuity is like giving a loan to the insurance company and they pay you back with interest in payment plans during an agreed distribution period.

The main advantage of investing in an annuity is that it is guaranteed. Unlike stocks, mutual funds, bonds, or even real estate that could fluctuate due to market conditions or economic downturns, the payments that you will get from your annuity investment is predictable and foolproof. The only way your annuity payments could be stopped is if the insurance company that issued you the annuity were to become insolvent.

In case of your death, an annuity can be paid out to your dependents. It is also possible to withdraw the payments early without penalty in case of a terminal illness or a disability. It will depend on the specifics of your annuity plan.

Who Usually Buys Annuity Products?

People who don’t want to risk their investment often choose annuity products because of the guaranteed payments. If you’re not someone who has a know-how on how the stock market works, an annuity could be a better investment for you to secure your financial health in the future.

Annuities are also popular with retirees who want to make sure they can still receive money even after they stop working. Or if you have some money now but you don’t want it sitting on your bank account because you’re afraid you’re going to spend it all, getting an annuity is also a good option. Some parents also buy annuities for their children so they can still receive guaranteed payments for many years instead of a one-time lump sum amount.

Can my Annuity Serve as a Collateral When Getting a Loan?

This will depend on the type of annuity that you have. There are different types of annuity products and depending on the type of annuity you have, you may or may not use it as a collateral when you are getting a loan. It is then important to understand what type of annuity you have.

What Types of Annuity Can be Used as a Loan Collateral?

Annuity products will differ depending on how much money you’re investing, how much you want to receive per payment, and how long the distribution period is. It will also depend on how soon you want to receive the money.

Based on when you want to start receiving payments, annuity products can be classified into two types:

1. Immediate Annuity Plans

These are annuity plans that are designed to immediately start payments after you make the investment. People who are already nearing retirement often go with immediate annuity plans.

2. Deferred Annuity Plans

After making the investment, the payment period will not start immediately. Instead, you will start receiving payments at a future date that you set. For example, you can buy an annuity plan when you’re 40 years old and decide to start receiving the payments only after you reach 60 years old.

Annuities can also be categorized based on the type of payment you will receive:

3. Variable Annuity Plans

With variable annuity plans, the earnings will depend on how much your investment performs. There is a promise of higher returns but the risk is also higher.

4. Fixed Annuity Plans

These are annuity plans that pay you a fixed amount over time, regardless of how much your investment earns. These types of products are for people who are not risk takers and just want a guaranteed income in the future.

When looking at the possibility of an annuity product as a loan collateral, you have to check whether it is a qualified or a non-qualified annuity plan.

5. Qualified Annuities

There are annuities that are bought with pre-tax money, usually through a traditional individual retirement account (IRA) or a retirement plan through your employer. These contributions are often deducted from your gross income and no taxes will be owed on that investment until after you retire or withdraw the money. When the distribution period starts, the regular payments will then be treated as income and you will be fully taxed on your contribution and the interest.

Qualified Annuities CANNOT be used as a collateral for a loan. However, these kinds of annuities typically have loan provisions. This means you can borrow against your annuity because in essence, you are borrowing from your own money. This kind of loan is called an Annuity Loan, which will be discussed later in this article.

6. Non-qualified Annuities

These are annuities bought with post-tax money, meaning the money that you used have been taxed already. These are not a part of a traditional IRA or pension plan. The difference is that with this kind of plan, you will only be taxed on the interest (earnings) when the distribution period starts because you have already paid taxes on your initial investment.

Non-qualified Annuities can be used as a collateral if you want to get a loan. But is it a good idea to use your non-qualified annuity as a loan collateral?

Read on to see the pros and cons.

Should I Use my Non-qualified Annuity as a Collateral for my Loan?

If you reach this point, you already probably know that if you have a non-qualified annuity, it is possible to use this as a loan collateral. However, you have to speak with your insurance provider to see what will be the specific implications of this move.

There are pros and cons of doing this. An obvious advantage is it will make it easier for you to get a loan if you need money ASAP. For example, you invested in a non-qualified deferred annuity 5 years ago and you’re not supposed to get payments for another 10 years but you now need money for a family emergency. If your credit standing is not good enough to get a personal loan or you don't have credit cards to cover your expenses, using your annuity could help you secure the loan that you need.

There’s a catch. When you use your annuity as a collateral for a loan, this loan amount will be considered by the Internal Revenue Service (IRS)  as a non-periodic distribution or withdrawal from your annuity. So even if you did not take money out of your non-qualified annuity, the IRS will still see it that way and tax you for that. You could also be subject to a penalty tax if you’re under 59 1/2 years of age. In short, using your non-qualified annuity as a collateral for a loan can cost you a lot of money.

I Have a Qualified Annuity Plan, Do I Have Other Options to Borrow Money?

Yes. As mentioned in the earlier section, a qualified annuity plan like a traditional retirement account typically has a loan provision. You can get an Annuity Loan.

What is an annuity loan? In an annuity loan, you are essentially borrowing from your own investments. This can be attractive for a person who needs money ASAP but doesn't want to go through the process of applying for a personal loan, especially if their credit standing is not good enough.

Usually, loans can be taken without tax consequences or penalties as long as you repay the amount within a set number of years (ex: 5 years). There is also a limit on how much you can borrow. For example, the IRS usually limits how much you can borrow from your retirement account but this can also change depending on the economic situation. Due to the Covid-19 pandemic, for instance, the IRS has relaxed rules on how much you can loan or pull out from your IRA.

But is getting an annuity loan financially sound? For some people, it could be their only choice but if you have other options, you should think of exploring them. You have to take note that the money that you will use to pay back your annuity loan will be post-tax money. Then when the distribution period starts after several years, you’ll have to pay tax again on the full amount that you will receive. In short, you would have to pay double tax on the same amount.

Using Your Annuity as a Source of Funds Can Cost You

Whether you’re considering using your annuity as a collateral or you’re thinking of getting an annuity loan, both of these actions could result in financial consequences. You have to speak to your insurance provider to clearly discuss what are the implications depending on the type of annuity plan that you have.

If you need quick cash, it might be worth exploring other options like getting online personal loans or even looking for ways to raise money fast before dipping into your annuity investment.