What are Annuities?
Annuities are insurance products that provide long-term income through a stream of future payments. While investment annuities save money for retirement and beneficiaries, structured settlement annuities stem from personal-injury legal cases, wrongful-death claims or lottery payouts. When unexpected circumstances arise and require immediate funds, you can sell these payments for a lump sum of cash.
There are many benefits to these investment products, which is why people planning for retirement, those who win the lottery and recipients of personal injury structured settlements use annuities most frequently. Some of those benefits include:
- Long-term security
- Tax-sheltered growth
- Safe and reliable investment
- Account for longevity
- Avoid probate
- Adjust to inflation
- Care for beneficiaries
- Structure payments around planned expenses
- Maintain an affordable retirement lifestyle
Is an Annuity Right for Me?
Choosing to fund an annuity can be a personal decision. Discuss with your spouse or loved before making this decision. It is also suggested that annuitants consult with an accountant or attorney before making this decision.
Consider these questions when talking with your financial advisor:
- What kind of annuity is right for me?
- Have I made maximum contributions to other retirement plans?
- Am I using a highly rated insurance company to buy my annuity?
- What is the cost? Are there any fees?
- Will I need my money sooner than 59 ½ years old?
- Who do I want to leave my assets to?
Should you have any additional questions about annuities, how they work, and the benefits of either type, the Annuity FAQs page can be a useful and comprehensive resource within your search.
Becoming an Annuity Owner
If you believe an annuity would be a good investment for you and your family, there are several easy steps to follow to get one:
- Find a Company and Finalize Your Contract – There are a variety of brokers, insurance companies and banks that issue annuities. Look at ratings from Fitch, Standard & Poor’s, AM Best and Moody’s to ensure you choose a reputable company.
- Purchase Your Annuity – An annuity is purchased in one of two ways: as a lump sum or with premiums.
Receive an Annuity as a Settlement Award – Following a lawsuit for a car accident, product defect or workers’ compensation claim, a court will award an annuity meant to provide for the plaintiff’s long-term financial needs.
- Lump Sum Payment – For this transaction, an annuity issuer would accept one large payment in exchange for immediate income within a year of purchase. An example of this annuity type is a single premium immediate annuity (SPIA).
- Series of Premiums – When choosing an annuity, owners can contribute a series of payments that will grow tax-deferred over period of years. At a later date, annuity payments will be disbursed to the annuitant. A deferred annuity is an example of this annuity type.
Understanding the Major Players
You’ll learn early on there are several key players involved in the annuity purchasing process: the insurance company that distributes the annuity, you as the annuity owner, your beneficiary, and an annuity buyer, should you choose to sell your annuity.
Insurance companies are annuity issuers. These businesses work with brokers, courts and individual buyers to create individually tailored annuity contracts, providing consumers with savings and investment options. They accept premiums, invest some of the funds, and over time provide annuitants with income through a series of payments.
Individuals or defendants pay premiums to insurance companies. The insurance company stores the money in tax-sheltered, interest-growing accounts. At a scheduled time, the owner of the account (which can be you or someone you assign to receive payments) receives cash in a lump sum or through a stream of payments which, in some cases, last through retirement.
Annuity buyers purchase future annuity payments in exchange for advancing cash. They work as a middleman, navigating between annuitants who need money now and companies scheduled to make payments in the future. This arena for selling payments—made up of annuity owners and buyers—is known as the secondary market.
When the owner of an annuity dies, remaining payments often transfer to a spouse or beneficiary. Every annuity contract includes a different set of rules to determine how many payments, if any, are passed on and who will receive them. Riders can also be purchased to increase the amount inherited. Designating a beneficiary helps to avoid a lengthy probate process and prevents remaining assets from being forfeited to an insurance company.
Pros & Cons of Annuities
There are a number of annuity options available to fit your financial needs, all of which have different benefits and functions. We can provide you with an in-depth look at how annuities work, the various types of annuities available to fit your financial needs, and how to sell your annuity payments in the event you need immediate access to cash. Continue reading for a peek at each annuity topic.
In addition, if you are grappling with the idea of buying or selling your annuity investment, but are unsure of the process, we can help to guide you on your financial journey.
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. This means you are spared from paying taxes on the principal growth until you receive income from your annuity.
- 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 an insurance company, unless you choose to invest in a variable annuity in which you carry some of the risk.
- Timed payments minimize taxes.
- Can be combined with other retirement benefits like a 401(k) or Social Security to pay for medical costs, living expenses and vacations to visit the grandkids.
- Provides income that allows you to put off other retirement benefits, such as Social Security payments, until you truly need them.
- Death benefits allow your money to quickly transfer to a loved one after you die, skipping probate.
- Annuities are another way to contribute to retirement funding if you’ve maxed out contributions to a 401(k) or IRA.
- 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 59 ½.
- Relinquish the lump-sum payment option when you buy an immediate annuity or annuitize your deferred annuity contract.
- Taxes applied to annuity payments may be higher in the future than they are now.
- Not insured by the FDIC or NCUA.
- Capital gains on annuities are not tax-deferred and are subject to regular income tax.
How Do Annuities Work?
Annuity owners pay an insurance company regular premium payments or a one-time lump sum in exchange for steady income payments that can last for the rest of their life or a fixed amount of years. For example, a $100,000 annuity can provide an annuitant with about $630 monthly, or about $7,600 yearly. Unlike a 401(k) or IRA, there is no limit to the amount you may put into an annuity.
Annuity savings grow tax-free and come with little to no risk.
Insurers will work one-on-one with you to set up a schedule tailored to your individual needs. If you want income immediately, plan for payments to start in a matter of months. However, if funds are withdrawn before the age of 59 ½, you will be subject to a 10 percent penalty tax or early withdrawal fee. If you want income once retirement begins, you can initiate payments decades after purchasing. In exchange for securing your finances, you can incur penalties or fees when trying to deduct funds early.
For more information on how annuities work, visit our pages on the following subtopics:
Buying, Splitting and Selling Annuities
While purchasing an annuity may have been a profitable financial option initially, needs can change over time. In addition to investing in this financial vehicle, annuities can be split and sold.
It is not uncommon for annuities to be shared or jointly owned between two parties. But just as they can be shared, annuities can also be split. This is a common option for divorcing couples, as they choose to split their remaining financial assets and marital property. Splitting an annuity is a complicated process that requires the original annuity contract to be split evenly into two new, identical contracts.
If buying or splitting an annuity are not ideal options for you, there is also the decision to sell your annuity. In the event that you need cash now, you can sell a portion or all of your annuity payments for a lump sum of cash. No matter how you choose to sell your annuity contract, the transaction does require court approval. It is also important to discuss all of your options with a financial advisor prior to making the decision to sell.
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For more information, please visit our buying, splitting and selling page or check out the following subtopics:
Types of Annuities
There are many different types of annuities available in the market. They vary in benefits, conditions, payouts and other factors.
Some of the most common types of annuities are:
- Immediate – Immediate annuities — also referred to as single-premium immediate annuities or SPIAs — allow investors to lock in a high interest rate to accrue interest over time. People approaching retirement are the largest segment of immediate annuity buyers because the annuity begins disbursement within one year of purchase. For this reason, an immediate annuity must be purchased with a lump sum. For example, a one-time payment of $100,000 could guarantee a retiree a immediate monthly income of $1,000 until their death.
- Deferred – A deferred annuity distributes income years after it is purchased. This waiting period is called an accumulation stage, when annuitants can make principal payments and the principal grows tax-deferred. Annuity distributions can be lump-sum payouts or periodic payments. For example, an annuitant at the age of 60 can make gradual premium payments that grow tax-deferred over a course of years. Once the annuitant reaches the age of 85, an insurance company will begin disbursing periodic payments until the annuitant’s death.
- Fixed – If you own a fixed annuity, the amount you will receive every month (or year, depending on the schedule) is predetermined and will not change. This limits growth but provides security.
- Variable – If you own a variable annuity, your returns are tied to the market and how the issuer invests your money. You have the chance to receive a bigger return, but you also take on risk.
There are also some unique special types of annuities, which include:
- Lottery – A lottery annuity is a structured settlement that disburses payments to its owner over a period of years, rather than paying the winning recipient a lump sum of money. This tool helps winners keep money for the long-term.
- Casino – People who win big in the casino have the option of using their winnings to purchase an annuity, which can ensure their future financial stability.
- Charitable Gift – A charitable gift is a form of planned giving from a donor to a charity. This form of annuity offers donors a return in exchange for their gift, while benefitting the designated charity.
- Pensions – Pensions pay the retiree a periodic, fixed amount based on salary and time of service with the employer before retirement. Defined benefit and defined contribution plans are popular examples of employer-offered pensions.
Withdrawing Money From an Annuity
Annuities are popular financial assets because they ensure a person’s funds are protected. This high level of security is a relief to most, but it can also be a problem if an annuity owner’s financial circumstances change and they need access to the funds in the annuity.
There are two options to get money from an annuity against the terms of the contract: via withdrawals or from selling the right to future payments.
If you face an emergency and have expenses you didn’t plan for, you can withdraw money from your annuity. As long as it is not more than your contract specifies and is after the first five to seven years of owning the annuity, you shouldn’t be penalized for an early withdrawal. However, if your withdrawal does occur during this time, you could face penalties from the IRS and fees from the insurance company that issued your annuity, called surrender charges. If you withdraw from the account before you reach 59 ½ years old, you will also face an IRS early withdrawal penalty of 10%.
If you need to take out a larger sum for a crisis or because you’re buying a bigger home for your growing family or you’re investing in a business, you can sell the right to future payments to an annuity purchaser for immediate access to cash. The purchaser, called a factoring company, will give you options for selling some or all or your payments. If you choose to sell your right to future annuity payments, it’s important to negotiate a fair price for your payments. There are many annuity value calculators available on the internet that can help you determine the current and future value of your annuity.
For additional information on selling your future payments and the selling process, visit our selling annuity payments page.