Types of Annuities
While the two major types of annuities include immediate and deferred, there are many options available to consumers like structured settlements, single premium, lotteries, pensions and workers' compensation, among others.
At one time, annuities were simple investment products that worked like old-time corporate pension plans. A classic, fixed annuity paid out a regular amount of money to a retiree based on how much was put into the account over the years by the owner, an employer or both.
Most of these traditional, deferred annuities provided the potential of a guaranteed stream of income for a lifetime, regardless of how much the annuitant originally invested.
That guarantee, along with growing returns, helped spike consumer demand for annuity products. Insurance companies responded by feeding that demand with more sophisticated types of annuity contracts, including variable annuities that offered higher payments if the value of their underlying securities rose and locked in minimum payments when the investments fell.
More innovations followed. Annuities were later increasingly tailored to individual investor needs and desires. Within the two main categories – deferred annuities and immediate annuities – investors have hundreds of annuity products to consider. They offer variations of payment and liquidity options, survivor benefits, investment models, guarantees against loss, plus many other choices. Structured settlements and single-premium annuities are included in these categories.
Because structured settlements provide periodic payments over time, they can be accomplished through the use of annuities. By the 1970s, annuities were the preferred vehicle for most structured settlement cases.
For example, in cases of a physical injury, a plaintiff and defendant might choose to negotiate the future medical and family needs of the injured party. Once they agree to terms, the defendant funds payments by assigning his obligation to the plaintiff through a third party, such as a life insurance company. That entity then agrees to fund the damage payments through an annuity.
Under the terms of the settlement contract, the annuitant can make many choices about how payments are structured, how the annuity's underlying assets will be invested, and how interest rates or returns might be guaranteed against loss. Once the terms are set, they can't be amended.
Unlike the annuities in corporate and personal retirement plans, where contributions are made over time, single-premium annuities are bought as one purchase with a lump-sum amount. The money can come from personal savings, a 401(k) plan that is rolled over into an Individual Retirement Account (IRA), an inheritance or any other source.
There are two forms of single-premium annuities: Immediate and deferred. The primary difference between the two is the moment at which they start generating income and length of time.
Immediate single-premium annuities begin paying out within a year of their purchase. Deferred single-premium annuities can accumulate interest over time. Payouts can begin any time in the future, depending upon investor needs.
Single-premium annuities can be variable or fixed. Variable annuities are funded by subaccounts invested in stocks, bonds and other equities. Fixed annuities are backed by a predictable rate of interest paid by the annuity's issuer.
In America, defined benefit retirement plans like company-sponsored pensions were replaced over the past few decades by defined contribution plans such as a 401(k) and Individual Retirement Accounts (IRAs). But many corporate and government pension plans still exist to pay out long-term benefits to their retired workers.
Federal law states a pension plan must provide a life annuity option that pays benefits until a retired worker dies or to a surviving beneficiary (typically a spouse) for the rest of their lives. A retiree whose pension comes from an annuity can choose from several different payout and survivor benefit options.
Although more companies today are giving their workers the option of taking their pension as a lump-sum distribution, some retirees are required to take their pension in the form of lifetime monthly payments from the annuity account set up for their benefit.
Once a decision is made on how a pension is to be taken, it cannot be reversed.
Anyone lucky enough to win a state lottery or Powerball often can decide whether to collect their winnings in a one-time, lump-sum payment or through a payment schedule that allows them to receive periodic disbursements.
If they choose the latter, payments come from an annuity account set up for them by their state’s lottery commission. However, unlike structured settlements that are the result of a personal injury suit or workers' compensation case, lottery distributions through an annuity are not tax-free.
Tobacco Lawsuit Annuities
Structured settlements via annuity contracts also are frequently set up for winners of tobacco lawsuits, especially when the damages are large. Thousands of lawsuits were filed against the country's major cigarette companies and verdicts in the tens of millions of dollars have been awarded to successful plaintiffs.
Other Types of Annuities
The use of structured settlements funded by annuities has grown from compensating people involved in car accidents or suffering other personal injuries, to a wide variety of different situations including:
- Workers injured on the job awarded worker compensation payouts
- People injured by defective consumer products
- Individuals who successfully sued for sexual harassment, age or racial discrimination, wrongful termination or violations of the Americans with Disabilities Act
- Individuals who suffered property loss due to construction defects
- Individuals who successfully sued for damages because of environmental harm
Annuity contracts have also been used in cases of divorce, business disputes, law firm break-ups and to pay attorneys’ fees.