How Do Annuities Work

How Do Annuities Work The term “annuity” basically refers to an arrangement that is made between two parties. One of these parties is generally an individual, who gives a sum of money, called the premium, in periodic payments or a lump sum, to the second party, which is often an insurance company. In return, the … Continue reading “How Do Annuities Work”

How Do Annuities Work

The term “annuity” basically refers to an arrangement that is made between two parties. One of these parties is generally an individual, who gives a sum of money, called the premium, in periodic payments or a lump sum, to the second party, which is often an insurance company. In return, the second party gives a steady stream of payment to the first party over a specified period of time that is stated in the arrangement.

Annuities consist of long term products and are a very straight forward approach to funding your future. However, before purchasing, it’s important for you to have a good understanding of what you’re buying.

There are two major kinds of annuity agreements. The first, called annuity certain, specifies the certain period for payment. For example, suppose you pay a certain amount of money to an insurance company for a twenty year annuity. You make an agreement whereby monthly payments are sent out along with a percentage growth, over the period of annuity. You will be a paid a specified amount of money, every month, till the arrangement comes to end.

The second type, called the life annuity, is most commonly employed by people who have retirement savings in mind. In this agreement, you pay a lump sum to the insurance company and they pay the money back to you at a specified amount every year for the rest of your life. Life annuities, when done in conjunction with a charity or a nonprofit organization, can offer extra tax benefits.

Among the many things you need to know about investing in an annuity is that it has mainly two types of balances that are running simultaneously. The first balance is your account value, also known as the contract value. This refers to the amount of money available to you at any given instance of time. It depends largely on the performance of the investments within the annuity that are also known as sub accounts.

The second one is the benefit base or the income base which is considered more as a hypothetical account. It is used to represent the amount of money that determines the annual guaranteed income one can draw from the annuity.

It is important to be aware of the differences between these two as sometimes you will come across variable annuities surrounding a guaranteed return that apply only to the income base and not to the actual account value. Income value is not the amount you can cash out. The only balance that you can withdraw when needed is your account value which may or may not be higher than your income base.

From time to time the insurance company will compare your account value with the income base. This, in most cases, is done on the anniversary date of the contract. If your account value turns out to be greater than your income base, then the insurance company will increase the benefit base such that it will be equal to the account value.

What Is A Secondary Market Annuity

What Is A Secondary Market Annuity

The term secondary market annuity or SMA in short refers to an in force, period certain payment stream. The term secondary market is used to differentiate these existing payment streams from primary market period certain annuities.

While there are payments in the marketplace that originate in lottery prizes and individually owned annuities. It’s important to clarify that most secondary market annuity transactions stem from structured settlement compensation. In example legal claims for personal injury or medical malpractice. It’s also important to note that these transactions have nothing to do with life settlements. Life settlements make bets on actuarial tables, but the secondary market annuities discussed here are period certain guaranteed receivables.

So, what are structured settlement annuities?

The majority of SMA’s in short are guaranteed payment streams backed by period certain annuities. These SMA’s are from major carriers that currently pay compensation for damages, injuries, or legal claims.

When an injured party elects to take their award as a structured settlement over time, U.S. tax code IRC 130 allows the plaintiff to receive their compensation free from income tax. By opting for a structured settlement over time rather than a lump sum, the plaintiff can receive both the award and the earnings of that award without tax liability.

Defendants typically use a qualified settlement fund or other vehicle to shift compensation for the injured party to a major carrier in a tax qualified manner. Defendants then generally purchase a life policy with period certain annuity to fund the specific payments due under the settlement. The qualified fund or an affiliated entity of the defendant is the annuity owner, and the plaintiff is the payee.

Structured settlements are a useful tool in the legal system that help provide for minors, help injured people support themselves if they are not able to work, and help reduce reliance on public support systems.

However, times change and often, payee’s under a settlement have a need for cash. As the payee’s are not the owners of the annuity, their payments are not convertible directly with the carriers into cash. Sellers of payments turn to factoring companies to purchase some or all of their future payments for cash today, and must accept a discount rate for those future payments.

Why the high yield?

When sellers sell at a discount, a secondary market annuity is created that offers the new recipient a higher-than-market rate of return. Buyers of secondary market annuities can receive yields 1 percent to 4 percent higher than comparable primary market, period certain annuities of similar credit quality.