How Does an Annuity Work?
An annuity preserves retirement money, allowing your nest egg to grow with long-term, tax-deferred savings, then later providing you with a future stream of income payments. However, if life interrupts your financial plan, you may decide to sell payments and access funds early.Get Cash Today
Types of Annuities
Here are different types of annuities available today in the market. They vary in benefits, conditions, payouts and other factors. Here are some of the most common types of annuities:
Immediate (Single Premium)
The single premium annuity is purchased with a lump sum of money and guarantees income instantly. People approaching retirement are the largest segment of immediate annuity buyers.
A lottery annuity is a structured settlement that disburses payment to its owner over a period of years, rather than paying the winning recipient a lump sum of money.
Pensions pay the retiree a periodic, fixed amount based on salary and time of service with the employer before retirement.
A deferred annuity delays payments during the accumulation stage, where your asset grow tax-deferred; and distributes payments in the income phase as a lump-sum payout, periodic payments or through annuitization.
Historians say annuities have been around since the Roman Empire. The Romans used them as lifetime income strategies, and not too much has changed since then. Today, there are different versions with varying benefits, as well as state and federal laws that protect annuity and structured settlement owners.
The primary annuity market over the last few decades also evolved from individuals purchasing annuities for retirement purposes to annuity owners selling their payments for immediate needs like buying a home. That evolution spawned the secondary annuity market.
A type of annuity often created as a result of a lawsuit where the defendant and plaintiff negotiate the future medical and family needs of an injured party. Once an agreement is reached, the defendant funds the structured settlement with periodic payments through a third party, usually a life insurance company. Some structured settlements allow for a partial lump-sum payment.
- Money awarded for a wrongful death claim.
- Winning the state lottery.
- Damages awarded from a workers' compensation case.
- Money awarded from a personal injury, lawsuit or insurance settlement.
Reasons for Structured Settlements
Pros & Cons of Annuities
Annuities can be useful in the right circumstances. You should be aware of all their available benefits, as well as their risks and drawbacks.
- Your money can grow tax-deferred.
- Safe investments generally backed by established insurance companies.
- Allows income for life, especially useful if you outlive your other available assets.
- Guaranteed against loss by taking risk out of your hands and transferring it to insurance company.
- Complex financial instruments with expensive fees, commissions and administrative charges.
- Your money is locked in for a certain period of time.
- Surrender charges and IRS penalties applied when withdrawing funds before age 59½.
- Relinquish the lump-sum payment option when you buy an immediate annuity or annuitize your deferred annuity contract.