I'd request an explanation of Structured settlement annuity agreement. I'm not quite sure about the payment system and the associated formalities.
Total Comments: 7
Posted: Tue Jun 29, 2010 03:50 pm Post Subject:
A structured settlement is one mandated by a court with the intent to preserve the money for the benefit of the injured party -- usually one without the capacity to appropriately manage the money due to age or mental deficiency.
Although judges commonly require such funds to be deposited in a CD or other "insured" (i.e., no risk to principal) account, it is not unheard of to use a fixed annuity as the conduit.
Annuities commonly have surrender penalties that prevent taking too much money from the contract in the early years without a financial disincentive (when the contract is not annuitized initially). The court will usually disallow such an annuity if it unreasonably restricts the injured party's ability to access the funds.
Insurers recognize this, and annuities for structured settlements are usually written with an endorsement waiving surrender penalties when the contract is not created as an immediate annuity.
Depending on the settlement amount and the age of the injured party, it may not be advisable to annuitize, since younger persons will receive smaller payments due to their extended life expectancy.
Contracts in such cases that have been annuitized have given rise to other companies that will "buy" structured settlements for lump sum amounts (you've probably seen their commercials on TV -- "my payment was too small, and it's my money"), which essentially subverts the court's intent in creating the settlement in the first place. It can be very complicated.
Do you have a more specific question?
Posted: Thu Jul 01, 2010 05:38 am Post Subject:
Apart from the waiver endorsement, are there any other specifications attached to such immediate annuity contracts? How're these surrender penalties calculated?
Posted: Thu Jul 01, 2010 12:56 pm Post Subject:
There are no surrender penalties in an "immediate" annuity. An immediate annuity begins making payments on a schedule either tied to the annuitant's life expectancy or to a specific number of years, such as 10 or 20. Once annuitized, the payments or the schedule which determined them cannot be altered.
A "deferred" annuity, by definition, delays the start of payments to some future point in time. Prior to that point, withdrawals may be taken subject to s surrender charge. Many deferred annuities permit 10-15% of the initial premium to be withdrawn without a penalty, and of the anniversary value in future years. Some are less generous.
The IRS uses the LIFO method (last in, first out) of taxation when it comes to taking money from a deferred annuity. This means that interest will be the last "thing" into the annuity's cash value. Assuming a premium paid of $100,000 (cost basis) and a first year interest crediting rate of 6%, a penalty-free $10,000 withdrawal on the last day of the contract year would result in a withdrawal of about $6,000 of taxable gain and $4,000 of basis. If the contract continues to be credited with 6%, in most contracts, the next year's withdrawal would be based on $96,000 of anniversary value.
In an immediate annuity, there is still taxation but the amount subject to taxation will be based on the amount of gain over the duration of the payments, and only a portion of the payments are taxed. If a lifetime income has been elected, at some point in time, 100% of the payments will become taxable, but only after all of the cost basis has been returned. A person might not live long enough for that to occur.
If any amount of an annuity's value is payable to a beneficiary, income tax is due only on the portion that exceeds the cost basis in the contract.
Posted: Fri Jul 02, 2010 04:23 am Post Subject:
Thanks for such a nice explanation!
So, does it mean that in an immediate annuity the taxed portion of payment would also be calculated upon the duration of payment?
Posted: Fri Jul 02, 2010 09:02 am Post Subject:
There is a formula known as the Annuity Exclusion Ratio. To simplify, it states that the premium paid (money IN) divided by the "expected" return (money OUT) results in a fraction that defines the amount of each payment EXCLUDED from taxation (the portion of the payment attributable to cost basis (money IN)).
$100,000/$200,000 = 1/2. If the payment is $500, 1/2 ($250) would be excluded from taxation.
A fixed period distribution (such as 10 or 20 years) would result in a series of fixed and equal monthly payments consisting of both principal and interest that self-exhausts at the last payment.
A life income annuity promises to pay throughout the lifetime of the annuitant, resulting in an "estimated" payout based on the annuitant's life expectancy. If the annuitant lives beyond the point that all principal has been distributed, the exclusion ratio no longer applies, because the remaining payments are all "gain" or "interest" (insurance company money). There are several variations on "life income" that promise unpaid principal in whole or in part to the annuitant's beneficiary if the annuitant does not live long enough to receive 100% of the contract's principal.
Posted: Sat Jul 03, 2010 05:56 am Post Subject:
Max, it's really good to know of the life income options that allow the beneficiary to have the principal (be it in part or in full).
But I'd like to get clarified more with the option when the annuitant lives to a point lesser than his life expectancy.
Posted: Sat Jul 03, 2010 12:25 pm Post Subject:
OK. First, let me list the most common annuity "settlement" (payment) options that would apply to a structured settlement annuity (there are other annuity options, but they would probably not be approved by the court):
(1) Life Income--payments for the lifetime of the annuitant, payments end at the death of the annuitant (unpaid principal remains with the insurer). The only guarantee is that payments will be made throughout the lifetime of the annuitant.
(2) Life Income with Period Certain--payments for the lifetime of the annuitant, with remaining payments guaranteed to a beneficiary if the annuitant does not live to the end of the guarantee period. Common guarantee periods are 12, 60, 120, 180, and 240 months (1, 5, 10, 20 years -- any number of months/years can be arranged -- the longer the guarantee period, the smaller the periodic payment). This is a "minimum guarantee" of principal and interest for the length of the guarantee period. It does not guarantee 100% of the principal will be paid to the annuitant or beneficiary.
(3) Life income with Cash (lump sum) Refund--payments for the lifetime of the annuitant. If the annuitant dies before all principal is exhausted, remaining principal is refunded to the annuitant's beneficiary. Guarantees 100% of the principal will be paid to the annuitant or beneficiary, plus interest.
(4) Life income with Cash (installment) Refund--payments for the lifetime of the annuitant. If the annuitant dies before all principal is exhausted, remaining principal is paid to the annuitant's beneficiary in continuing installments with interest until all principal has been paid. Guarantees 100% of principal will be paid to the annuitant or beneficiary, plus interest. Total of principal and interest paid will exceed that of (3) above.
(5) Fixed Period--Annuitant selects a specific number of months over which principal will be paid (12, 60, 120, 180, 240, or more). Insurer calculates the interest payable during that time and adds it to the principal, then divides the total amount by the number of payments. Annuitant receives a monthly payment for the entire specified period. If the annuitant dies before all payments have been made, the annuitant's beneficiary may elect to receive the remaining principal in a lump sum, or the continuing payments until the final payment is made. Guarantees 100% of principal will be paid. At the end of the stated period, payments end.
(6) Fixed Amount--annuitant determines the amount of monthly payment desired. Insurer pays that amount each month (a combination of principal and interest on declining principal) until all principal is exhausted. If the annuitant dies before all principal has been paid, the annuitant's beneficiary may elect to receive the principal in a lump sum, or as a continuing series of payments until the principal is exhausted. Guarantees 100% of principal will be paid.
From (1) to (4) this is the order of payments from highest to lowest. In other words, the life income option (with no guaranteed payments to a beneficiary) provides the highest possible payment and the installment refund annuity will pay the smallest monthly payment.
The fixed payment options (5) and (6) do not provide lifetime income, but the payment amount will be known, and 100% of the principal will be paid plus interest. (They are "opposite sides of the same coin".)
================================================
In deciding which option to choose, the insurer will provide an explanation of how much each of the options will pay so that all interested parties will be informed as to the difference each choice will make.
The court will generally approve any of these options, but may caution against selecting the life income (1) or period certain (2) options, since the idea is not to enrich the insurer, but to see that the annuitant (or their heir) receives the agreed settlement amount. For that reason, most structured settlement annuities are based on options (3) through (6), so that 100% of the settlement amount is ultimately received by one or more persons.
The court's intent with a structured settlement is to make sure the person (plaintiff) has money for living expenses or other needs. It is sometimes a recognition that the person does not have the capacity to manage a large amount of money (might be a minor, might be mentally impaired). It can lead to a person not necessarily having enough money each month as inflation affects purchasing power.
This is the reason there are companies willing to buy out a structured settlement. They are assured of getting all of the remaining money. They profit by giving the annuitant only 75-80 cents on the dollar (maybe even less) for the remaining value of the payments. The annuitant gets a lump sum today, rather than having to wait for the full amount over time. Annuitants may decide to sell out because they are dissatisfied with the amount of their monthly payment.
Posted: Tue Jun 29, 2010 03:50 pm Post Subject:
A structured settlement is one mandated by a court with the intent to preserve the money for the benefit of the injured party -- usually one without the capacity to appropriately manage the money due to age or mental deficiency.
Although judges commonly require such funds to be deposited in a CD or other "insured" (i.e., no risk to principal) account, it is not unheard of to use a fixed annuity as the conduit.
Annuities commonly have surrender penalties that prevent taking too much money from the contract in the early years without a financial disincentive (when the contract is not annuitized initially). The court will usually disallow such an annuity if it unreasonably restricts the injured party's ability to access the funds.
Insurers recognize this, and annuities for structured settlements are usually written with an endorsement waiving surrender penalties when the contract is not created as an immediate annuity.
Depending on the settlement amount and the age of the injured party, it may not be advisable to annuitize, since younger persons will receive smaller payments due to their extended life expectancy.
Contracts in such cases that have been annuitized have given rise to other companies that will "buy" structured settlements for lump sum amounts (you've probably seen their commercials on TV -- "my payment was too small, and it's my money"), which essentially subverts the court's intent in creating the settlement in the first place. It can be very complicated.
Do you have a more specific question?
Posted: Thu Jul 01, 2010 05:38 am Post Subject:
Apart from the waiver endorsement, are there any other specifications attached to such immediate annuity contracts? How're these surrender penalties calculated?
Posted: Thu Jul 01, 2010 12:56 pm Post Subject:
There are no surrender penalties in an "immediate" annuity. An immediate annuity begins making payments on a schedule either tied to the annuitant's life expectancy or to a specific number of years, such as 10 or 20. Once annuitized, the payments or the schedule which determined them cannot be altered.
A "deferred" annuity, by definition, delays the start of payments to some future point in time. Prior to that point, withdrawals may be taken subject to s surrender charge. Many deferred annuities permit 10-15% of the initial premium to be withdrawn without a penalty, and of the anniversary value in future years. Some are less generous.
The IRS uses the LIFO method (last in, first out) of taxation when it comes to taking money from a deferred annuity. This means that interest will be the last "thing" into the annuity's cash value. Assuming a premium paid of $100,000 (cost basis) and a first year interest crediting rate of 6%, a penalty-free $10,000 withdrawal on the last day of the contract year would result in a withdrawal of about $6,000 of taxable gain and $4,000 of basis. If the contract continues to be credited with 6%, in most contracts, the next year's withdrawal would be based on $96,000 of anniversary value.
In an immediate annuity, there is still taxation but the amount subject to taxation will be based on the amount of gain over the duration of the payments, and only a portion of the payments are taxed. If a lifetime income has been elected, at some point in time, 100% of the payments will become taxable, but only after all of the cost basis has been returned. A person might not live long enough for that to occur.
If any amount of an annuity's value is payable to a beneficiary, income tax is due only on the portion that exceeds the cost basis in the contract.
Posted: Fri Jul 02, 2010 04:23 am Post Subject:
Thanks for such a nice explanation!
So, does it mean that in an immediate annuity the taxed portion of payment would also be calculated upon the duration of payment?
Posted: Fri Jul 02, 2010 09:02 am Post Subject:
There is a formula known as the Annuity Exclusion Ratio. To simplify, it states that the premium paid (money IN) divided by the "expected" return (money OUT) results in a fraction that defines the amount of each payment EXCLUDED from taxation (the portion of the payment attributable to cost basis (money IN)).
$100,000/$200,000 = 1/2. If the payment is $500, 1/2 ($250) would be excluded from taxation.
A fixed period distribution (such as 10 or 20 years) would result in a series of fixed and equal monthly payments consisting of both principal and interest that self-exhausts at the last payment.
A life income annuity promises to pay throughout the lifetime of the annuitant, resulting in an "estimated" payout based on the annuitant's life expectancy. If the annuitant lives beyond the point that all principal has been distributed, the exclusion ratio no longer applies, because the remaining payments are all "gain" or "interest" (insurance company money). There are several variations on "life income" that promise unpaid principal in whole or in part to the annuitant's beneficiary if the annuitant does not live long enough to receive 100% of the contract's principal.
Posted: Sat Jul 03, 2010 05:56 am Post Subject:
Max, it's really good to know of the life income options that allow the beneficiary to have the principal (be it in part or in full).
But I'd like to get clarified more with the option when the annuitant lives to a point lesser than his life expectancy.
Posted: Sat Jul 03, 2010 12:25 pm Post Subject:
OK. First, let me list the most common annuity "settlement" (payment) options that would apply to a structured settlement annuity (there are other annuity options, but they would probably not be approved by the court):
(1) Life Income--payments for the lifetime of the annuitant, payments end at the death of the annuitant (unpaid principal remains with the insurer). The only guarantee is that payments will be made throughout the lifetime of the annuitant.
(2) Life Income with Period Certain--payments for the lifetime of the annuitant, with remaining payments guaranteed to a beneficiary if the annuitant does not live to the end of the guarantee period. Common guarantee periods are 12, 60, 120, 180, and 240 months (1, 5, 10, 20 years -- any number of months/years can be arranged -- the longer the guarantee period, the smaller the periodic payment). This is a "minimum guarantee" of principal and interest for the length of the guarantee period. It does not guarantee 100% of the principal will be paid to the annuitant or beneficiary.
(3) Life income with Cash (lump sum) Refund--payments for the lifetime of the annuitant. If the annuitant dies before all principal is exhausted, remaining principal is refunded to the annuitant's beneficiary. Guarantees 100% of the principal will be paid to the annuitant or beneficiary, plus interest.
(4) Life income with Cash (installment) Refund--payments for the lifetime of the annuitant. If the annuitant dies before all principal is exhausted, remaining principal is paid to the annuitant's beneficiary in continuing installments with interest until all principal has been paid. Guarantees 100% of principal will be paid to the annuitant or beneficiary, plus interest. Total of principal and interest paid will exceed that of (3) above.
(5) Fixed Period--Annuitant selects a specific number of months over which principal will be paid (12, 60, 120, 180, 240, or more). Insurer calculates the interest payable during that time and adds it to the principal, then divides the total amount by the number of payments. Annuitant receives a monthly payment for the entire specified period. If the annuitant dies before all payments have been made, the annuitant's beneficiary may elect to receive the remaining principal in a lump sum, or the continuing payments until the final payment is made. Guarantees 100% of principal will be paid. At the end of the stated period, payments end.
(6) Fixed Amount--annuitant determines the amount of monthly payment desired. Insurer pays that amount each month (a combination of principal and interest on declining principal) until all principal is exhausted. If the annuitant dies before all principal has been paid, the annuitant's beneficiary may elect to receive the principal in a lump sum, or as a continuing series of payments until the principal is exhausted. Guarantees 100% of principal will be paid.
From (1) to (4) this is the order of payments from highest to lowest. In other words, the life income option (with no guaranteed payments to a beneficiary) provides the highest possible payment and the installment refund annuity will pay the smallest monthly payment.
The fixed payment options (5) and (6) do not provide lifetime income, but the payment amount will be known, and 100% of the principal will be paid plus interest. (They are "opposite sides of the same coin".)
================================================
In deciding which option to choose, the insurer will provide an explanation of how much each of the options will pay so that all interested parties will be informed as to the difference each choice will make.
The court will generally approve any of these options, but may caution against selecting the life income (1) or period certain (2) options, since the idea is not to enrich the insurer, but to see that the annuitant (or their heir) receives the agreed settlement amount. For that reason, most structured settlement annuities are based on options (3) through (6), so that 100% of the settlement amount is ultimately received by one or more persons.
The court's intent with a structured settlement is to make sure the person (plaintiff) has money for living expenses or other needs. It is sometimes a recognition that the person does not have the capacity to manage a large amount of money (might be a minor, might be mentally impaired). It can lead to a person not necessarily having enough money each month as inflation affects purchasing power.
This is the reason there are companies willing to buy out a structured settlement. They are assured of getting all of the remaining money. They profit by giving the annuitant only 75-80 cents on the dollar (maybe even less) for the remaining value of the payments. The annuitant gets a lump sum today, rather than having to wait for the full amount over time. Annuitants may decide to sell out because they are dissatisfied with the amount of their monthly payment.
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