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Annuities, put simply, are a contract between an individual and an insurance company where the individual pays a premium in exchange for periodic income payments from the insurance provider. While annuities are most often associated with retirement planning, there are a number of different types. It is certainly worth knowing what products are available, considering the fact that Americans presently own more than $1Trillion in annuities.¹
The main types of annuities are fixed, variable and fixed indexed. These financial products vary based on interest-rate risk and potential yields from payment to payment. Understanding the risk involved with each annuity choice will help you determine your payment amounts and/or adjust your expectations regarding payments.
Typically, the choice between the types of annuities will be ironed out in the initial contract, allowing annuity owners to gauge their expectations on the amount they will receive in each payment. The primary difference between these two classifications deals with whether or not dollar amounts will fluctuate from payment to payment.
In the case of a fixed annuity, every periodic payment is a set, unchanging amount with a set interest rate. These types of annuities allow individuals to count on a consistent payment which will remain the same each and every time. Therefore, fixed annuities present a low risk with a predictable yield.
Variable annuities involve payments which can vary based on the performance of the fund’s investments. If the investment is performing strongly, annuity owners will see greater returns. However, if the investment is not performing well, one might experience lower payment amounts than they are used to.
Fixed indexed annuities, also known as indexed or equity-indexed annuities, balance the risk and rewards of fixed and variable annuities. Fixed indexed products offer more potential for growth than fixed annuities because the interest rate is tied to a specific index like a stock market index, which can yield a greater dollar amount. The interest also won’t fall below a predetermined amount, making this less risky than variable annuities. With that being said, this type of annuity can carry higher fees and costs than fixed annuities.
Broadly speaking, there are two primary classifications of annuity payout options: deferred and immediate. The distinction between these two types of annuities depends on when the annuity owner prefers to receive funds ‒ now, or at a specified later date.
Immediate annuities are those which have no accumulation period. This means that annuity payments will begin within one year of paying the initial premium to the insurance provider. This is also referred to as an income annuity.
Deferred annuities are tax-deferred financial products that have a set period of accumulation, which is the length of time between paying a premium and receiving the annuity payments. The investor will receive payments at a future date such as when they retire.
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While there are just a few overarching characteristics of annuities, the number of annuity products can vary greatly from things like lottery and casino winnings to charitable gift annuities.
If someone is fortunate enough to win the lottery, they may be faced with the choice of accepting their money as a lump sum or in the form of an annuity. The latter option involves setting up an annuity contract with the state lottery commission. While an annuity for lottery winnings has many of the same characteristics of more common structured payment annuities, it is important to note that they are likely not tax free.*
If you are thinking “Why would I defer lottery winnings to an annuity instead of taking it all at once?” consider the fact that people often spend their winnings fast and frivolously. Opting to receive payments as an annuity gives lottery winners the ability to spread payments out over time and ideally make the money benefit them in the long run. Additionally, depending on the terms of the annuity contract, lottery winners may be able to earn interest on the payments they defer for longer periods of time
Not far off from lottery annuities, casino gambling winnings can typically be dispersed as a one-time lump sum or in the form of an annuity. Since a lump sum provides the full payment amount up front, a winner would be required to pay taxes immediately on the entire amount. Choosing an annuity requires individuals to pay taxes as they earn the money.²
A charitable gift annuity is an agreement between an annuitant and a charity organization in which the charity will receive the remaining balance from the annuitant’s income stream upon the annuitant’s death. The annuitant’s regular payments are based on the value of assets given to the organization and essentially act like a life annuity.
Charitable gift annuities offer regular income for the annuitant for their lifetime, tax deductions to the annuitant on the initial lump sum gift and on annuity payouts, and potential income to spouses or beneficiaries depending on the contract.³
Annuity buyers can guarantee income for a set period (fixed period annuities) for the rest of the buyer’s lifetime (lifetime annuities). Fixed period annuities are spread out over a fixed period. For example, lottery winners can set up a fixed period annuity to receive payments over the course of several decades. On the other hand, lifetime annuities enable annuity buyers to receive payments for the rest of their lifetime, which is based on their age and health. As the annuitant gets older, individual payments are expected to reduce in amount.
Depending on the circumstances, designated beneficiaries can receive payments after the annuity owner’s death. For instance, an annuitant who is married may choose a joint and survivor annuity, which covers both partners. The annuity will pay for the rest of the annuity buyer’s life or the rest of the spouse’s life (whichever partner’s life lasts longer).
If you are receiving annuity payments but need to access to your money sooner and have questions about your ability to sell your annuity payments for a lump sum of cash, call Peachtree Financial Solutions at 1 (800) 581-1091. We offer customized solutions to meet your financial needs.
1. https://www.investopedia.com/terms/a/annuity.asp
2 https://www.investopedia.com/advisor-network/articles/lottery-winnings-take-lump-sum-or-annuity/
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