Have you ever played the lottery? The chances are that you have considered that about half of Americans play state lotteries. And, while your hard-earned money could be put to better use when you purchase a ticket or scratch it off, you have two payout choices; annuity or lump sum.
An annuity option, commonly known as a lottery annuity, pays you the prize amount over time. For example, for Mega Millions and Powerball, annuity payments are disbursed over 29 years. With a lump-sum payout, your total winnings are distributed at once — after taxes.
In its purest form, this is a basic definition of what an annuity is; a fixed sum of money paid to someone each year, typically for the rest of their life. In fact, “the word annuity is derived from the Latin, annus, or year, and the Latin, annuities,” explains Daniel Cotter, the Attorney on record for Due. “The reason for this is because annuities are investments that entitle the holder to equal annual payments.”
But, when we often refer to annuities, we’re actually talking about a more meaningful investment than playing the lottery.
An annuity is nothing more than an insurance product that guarantees a lifelong income.
More specifically, an annuity is a legal and enforceable contract between you and the insurance company who you’ve purchased the annuity from. The insurance company assumes the risk of you outliving your savings when signing this contract. To compensate for this risk, you pay premiums to the annuity company.
But, annuities come in different shapes and sizes. As such, if you’re considering an annuity, you should be familiar with the basic definitions of annuities.
A-Share Variable Annuities
A-share variable annuities, like mutual funds, have up-front sales charges instead of surrender charges. Each premium payment is charged a percentage of the sales charge. With breakpoint pricing, up-front sales charges decrease depending on the cumulative amount of purchases made.
Annuity
A periodic income payable to a person or to a group for a specified period of time. A legally binding agreement by which an insurer promises to pay a certain amount over a given number of years.
B-Share Variable Annuities
This type of annuity contract is characterized by deferred sales charges, which typically fall to zero after five to seven years. Among annuity contracts, B-shares are the most common.
Bonus Annuity
An annuity where the insurance company adds a bonus amount, usually a percentage of what you put into your annuity when you buy or add money to it.
C-Share Variable Annuities
C-share VAs have no upfront or back-end fees, like C-share mutual funds. An investor can sell any or all shares without paying any additional fees or costs.
CD-type Annuity
Also known as multi-year guaranteed annuities, these are fixed annuities for which interest rates are guaranteed in advance.
Deferred Annuity
An annuity that hasn’t yet begun paying out income. When purchasing deferred annuities, the money is left to grow inside the contract for a period of time before the payout is activated as it’s considered a long-term investment. Deferred annuities can either be fixed or variable.
Deferred Income Annuity
“A deferred income annuity (DIA) allows you to use a lump sum or multiple purchases to receive a guaranteed ‘retirement paycheck,'” explains Charles Schwab. “The DIA provides guaranteed income (your “retirement paycheck”) beginning at a future date of your choice (generally, 13 months to 40 years from the initial purchase).”
Also known as a longevity annuity.
Equity-Indexed Annuity
Also known as an indexed annuity or fixed–index, this type of annuity pays interest based in part on the performance of a stock market index, such as the S&P 500. The insurance company that issues and guarantees the contract typically sets the growth rate of the contract annually. It also offers principal protection in the event of an economic downturn.
Fixed Annuity
Fixed annuities are essentially insurance contracts that promise payments to their buyers. Depending on the amount the buyer contributes to the account, they guarantee a specific interest rate. The buyer either pays the insurance company a lump sum or makes a series of payments over time. In return, they’re given a fixed amount of income over their lifetime.
Fixed Period Annuity
Payout option for a set period of time rather than a lifetime payout.
Flexible-Premium Annuities
This kind of annuity is usually funded over many years. You can also choose to pay premiums in different amounts (within a minimum and maximum) on a fixed schedule or as you wish. As your assets accumulate, they can be used to fund either a fixed or variable deferred annuity.
Hybrid Annuity
Term used to describe an indexed fixed annuity with an optional income rider.
I-Share Variable Annuity
Investment advisors manage variable annuities for a fee, also known as fee-based variable annuities. The advisor does not receive a commission on I-shares. Nonetheless, the advisor charges a fee for the services, including the I-share contract, which is negotiated between the advisor and the client.
Immediate Annuity
Immediate annuities, sometimes called Single Premium Immediate Annuities (SPIA), are quite similar to other annuities. You and the insurance company enter into a contract wherein an income is guaranteed.
However, unlike a deferred annuity, an immediate annuity bypasses the accumulation phase. That means you will receive payments almost immediately, rather than in 20 years. If you pay a lump sum for the premium, payments are usually issued within a year.
Income Annuity
Consumers can convert all or part of their savings into a guaranteed source of income, either for life or for a specific period of time. Payments from an income annuity may be immediate or deferred.
Joint and Survivor Annuity
In a joint annuity, two annuitants, usually spouses, receive their payments for the rest of their lives.
L-Share Variable Annuities
There are no upfront charges with L shares, but there is a 3- to 4-year surrender period and fees. L shares typically have higher mortality and expense (M&E) and administrative fees than other share classes.
Life-with-Period Certain Annuity
A type of annuity with smaller payments, but with guaranteed payments. Upon the death of the annuitant, beneficiaries will receive the payments. In the event annuitants outlive the payment period, they continue to collect income until they die.
Multi-Year Guarantee Annuities
A fixed annuity where the interest rate is guaranteed in advance for a particular period of time.
Non-Qualified Annuity
A retirement annuity is purchased with after-tax dollars, i.e., with money not placed into a tax-deferred retirement account. Therefore, deducting non-qualified annuity premiums from gross income is not possible.
O-Share Variable Annuities
This product combines features of A and B shares. It’s often geared towards long-term investors. There are very few insurers that offer this share class. As with B shares, O shares do not have any up-front charges (unlike A shares). The M&E costs decline during the surrender period until they are similar to those of A-shares (typically lower than B shares). Commission trails will likely be affected for brokers and advisors.
Qualified Annuity
An annuity contract is purchased using pre-tax funds, such as those from a 401(k) or an IRA. In the year you purchase a qualified annuity, the money you use is subtracted from your annual income. The annuity is taxed only when you begin receiving the proceeds, usually at retirement.
Qualified Longevity Annuity Contract (QLAC)
Investments in a qualified retirement plan or individual retirement account are used to fund a deferred annuity. QLAC payouts are protected against stock market fluctuations, continue until death, and can be used to defer the required minimum distribution.
Qualified Pre-Retirement Survivor Annuity (QPSA)
If a plan participant dies before retirement, the plan participant’s spouse receives a regular income.
Refund Annuity
In an annuity contract, the annuitant receives a lump sum at death, which is added to the total payment of the annuity.
Registered Index-Linked Annuity (RILA)
A stock market index determines Gains and losses for an annuity. You can set the maximum loss you will tolerate with a RILA, previously known as a buffered annuity.
Secondary Market Annuity (SMA)
An annuity bought on the secondary market.
Single-Premium Immediate Annuity (SPIA)
An annuity in which payments begin within a year and provide the individual or joint with a guaranteed income stream for a set amount of time. You can also structure them to receive guaranteed income for a specific period of time.
Often purchased in a lump sum using cash from an inheritance, a legal settlement, or a business sale. The money could be used to fund an immediate or deferred annuity.
Straight Life Annuity
A form of annuity income pays during the annuitant’s lifetime (s) and terminates when that annuitant(s) dies.
Structured Settlement
A legal settlement funded with annuities or another form of qualified funding.
Tax-Sheltered Annuities
A retirement plan for tax-exempt organizations or schools is governed by the Internal Revenue Code (IRC) section 403(b). A tax-sheltered annuity is funded through pre-tax contributions. Additionally, employers can make direct contributions on employees’ behalf.
Variable Annuity
Variable annuities are also contracts between you and your insurance company. The account serves as a tax-deferred investment vehicle. Variable annuities offer insurance benefits in the form of guaranteed payments, which you can purchase with one payment or multiple payments over time.
Unlike its annuity counterparts, you can also choose a wide range of investment options with a variable annuity. These subaccounts will determine the value of your contract.
If your investment options perform well, they may increase or decrease the value of your contract. Usually, you can invest in stocks, bonds, and money market instruments through mutual funds. Alternatively, you can choose a combination of these investments.
X-Share Variable Annuities
X-share VAs credit a percentage of the initial premium as a bonus. A $100,000 investment might become $103,000 when the contract is first issued, for instance.
The surrender period and ongoing costs of X-share contracts are generally longer than those that do not offer bonuses. If the investor assumes an annual net return of 6-8 percent per year, then the bonus (and any compounding) makes sense.
