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.

What are the Different Types of Annuities

Although they may seem like a modern kind of financial investment, annuities were first introduced in ancient Rome as a form of payment for a soldier’s service. Annuities have since grown into a high-demand product with more sophisticated types of annuity contracts tailored to individual investor needs and desires.

In 2011, annual annuity sales were $240 billion. American consumers currently own more than $1 trillion worth of annuities.

Within the two main categories – deferred annuities and immediate annuities – investors have hundreds of annuity products to consider, including:

  • Lottery Annuities
  • Casino Winning Annuities
  • Pensions
  • Charitable Gift Annuities
  • Secondary Market Annuities

These special kinds of annuities offer a variety of payment and liquidity options, survivor benefits, investment models, guarantees against loss and many other choices.

Lottery Annuities

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 an annuity that disburses annual payments over a period of time.

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.

Annuity vs. Lump Sum Lottery Payments

Though both options guarantee a lottery payout, the lump sum and long-term annuity options have different benefits. Other than providing immediate gratification, a lump sum payout option helps winners avoid long-term tax implications since they are required to pay taxes on their winnings once, on receipt. A lump sum also provides the opportunity to immediately invest in larger assets like stocks and real estate.

A lump sum payout may influence winners to make extravagant purchases and poor choices.

In addition, the taxes may significantly decrease the final amount disbursed. If the annuity earns interest, any withdrawal of the interest will be taxed as ordinary income. The principal amount cannot be taxed again.

On the other hand, receiving a long-term lottery annuity guarantees winners a stream of income for a longer period of time and may provide a larger payout in the end. A long-term annuity also has the ability to accrue interest over time. However, an annuity contract is inflexible, prohibiting winners from changing the contract terms or receiving a larger sum in the event of an unexpected financial or family emergency.

Casino Winnings

Similar to lottery winnings, casino winnings can be disbursed through long-term annuity payments with gradual tax implications or as a one-time lump sum. However, the payout is sometimes determined by the game played. Some common slot machines disclose whether it is an annuity game or an immediate full-win.

An annuity payout or a lump sum option both have their own set of tax implications. While a lump sum option provides a large sum of cash up front with ample flexibility, winners are subject to paying taxes on the sum all at once in the same year the winnings are distributed. This option requires them to settle for a discounted rate of 50 to 60 percent of the total winnings.

However, leaving casino winnings in an annuity can negatively influence their value. An annuity payout option can take 20 to 30 years to fully disburse, which provides steady income until the end of the contract terms. The downside is that the winnings could depreciate in value due to inflation. Annuity contracts are also inflexible and may not allow winners to make bigger purchases or alleviate immediate debt.

Pensions

Pensions are employment benefits used to help secure a retirement nest egg. There isn’t much of a difference between a pension and annuity. Prior to becoming a popular benefit in the United States, pensions were used in ancient Rome as payment for a soldier’s service. This benefit eventually gained popularity when President Franklin Roosevelt introduced the world’s largest pension plan with the Social Security Administration, which became a popular and profitable citizen benefit following World War II.

Defined benefit retirement plans like company-sponsored pensions have been replaced over the past few decades by defined contribution plans such as a 401(k) and Individual Retirement Accounts (IRAs).

Pensions and annuities have similar benefits. Like an annuity, some pension recipients can choose how to receive their benefit distribution. While some companies give 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.

Federal law states a pension plan must provide a life annuity option that pays benefits to a surviving beneficiary or a spouse.

In addition, pensions can be transferred to a spouse or beneficiary in the event the owner dies. The payments are meant to last the remainder of their lives. A retiree whose pension comes from an annuity can choose from several different payout and survivor benefit options.

Charitable Gift Annuities

Charitable gift annuities are purchased on behalf of a financial donor as a gift to a charity. In exchange for a tax benefit and a lifetime annuity, the financial donor transfers assets to the charity. When the donor dies, the charity retains all remaining funds.

While charities and financial investors both benefit directly from a charitable gift annuity, this financial tool also helps organizations build long-term relationships with donors. In the 1920s, charitable gift annuities were used as a fundraising strategy for churches and other charities. Since then, universities, community foundations, nonprofits and social service organizations, to name a few, have adopted this tactic not only to retain funding for projects and programs but also to build a fellowship of supporters.

How Does a Charitable Gift Annuity Work?

Charitable gift annuities operate as an exchange of a cash gift or property for a stream of lifetime payments. This annuity option is referred to as a split gift since a portion of the gift is used immediately by the receiving charity, and the other portion is invested and used to provide lifetime income payments to the donor or annuitant. The donor(s) can be an organization or an individual looking to invest in a charitable organization.

The amount of the annuity payout is determined by the donor’s age and the size of the donation. For example, based on a payout rate of 6.1 percent, a 70-year old donor gifting a charity with $50,000 would receive a yearly disbursement $3,050 until their death.

Secondary Market Annuities

Within a short time, the secondary market has become a regulated and competitive industry, allowing an annuitant to sell all or a portion of his or her future payments for less than the total amount he or she would have received if the payments were to continue. Though annuitants lose the ability to receive long-term income, they gain the ability to receive immediate cash. This industry developed after laws allowed annuity owners to sell all or a portion of their annuity assets for immediate access to funds.

The secondary market is a marketplace where assets are traded among investors without involving issuing insurance companies.

In 1982, Congress passed the Periodic Payment Settlement Act, encouraging the use of structured settlements in physical injury cases by amending the federal tax code. The law provided that 100 percent of every structured settlement payment, including any interest or gains accrued on its underlying investment vehicle, would be exempt from federal, state and local income taxes.

While the legislation resulted in an explosion of annuity contracts being issued by insurance companies, it also increased the number of annuity owners who wanted to sell the future payment rights of their contracts for immediate cash buyouts. To serve this growth, a secondary market arose.

However, this new industry left annuitants vulnerable since there were no asset protections or government regulation. Since then, 49 states have implemented their own version of a Structured Settlement Protection Act (SSPA), which are regulations meant to provide consumers with effective financial safeties to protect their assets.

Page Sources

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  3. Ritchie, A. (n.d.). Charitable Gift Annuities. Retrieved from https://www.annuity.org/annuities/types/charitable-gift/
  4. Ritchie, A. (n.d.). Lottery Annuity Payments. Retrieved from https://www.annuity.org/annuities/types/lottery/
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