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
Deferred Annuities vs. Immediate Annuities
Broadly speaking, there are two primary classifications of annuities: deferred and immediate. The distinction between these two types of annuities is fairly simple — deferred annuities have a set period of accumulation, which is the length of time between paying a premium and receiving the annuity payments. Conversely, 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.1
Fixed Annuities vs. Variable Annuities
Within each general type of annuity, the classification breaks down further into fixed and variable annuities. Typically, the choice between fixed and variable 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. These types of annuities allow individuals to count on a consistent payment which will remain the same each and every time.
Variable annuities, on the other hand, 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.1
Common Forms of Annuity Products
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.2
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