Glossary of Human Resources Management and Employee Benefit Terms
An annuity is a long-term contract with an insurance company that guarantees the employee a steady stream of income at a future date, most frequently after retirement.
Annuities are a way to save additional money for retirement. Annuity contracts require employees to make a series of payments in exchange for income paid out on a regular basis. An annuity contract can be purchased independently, or employees may receive one through their employer.
The payments you make in an annuity contract are generally fixed (you received a definite amount of pay) or variable (you receive various amounts of pay).
There are several types of annuities, such as:
Immediate annuities: You pay a lump sum or a series of smaller payments in exchange for payments made to you immediately. This is usually the case if you’re ready to retire soon.
Deferred annuities: While immediate annuities give you payments right away, deferred annuities provide payments at a predetermined date in the future. There are different types of disbursement timelines for deferred annuities. For example, you could choose a plan that makes payments 15 or 25 years from now (depending on when you plan to retire) and continues for the rest of your life.
Qualified employee annuities: An employee may also seek annuities under their employer, in which the employer may have a qualified employee annuity program.
A qualified employee annuity is a retirement savings plan purchased by an employer for their employee. Qualified annuities are funded with pre-tax dollars, meaning there are no taxes owed on money that accrues in the account, given that no withdrawals are made.
Per IRS standards, there are qualified and non-qualified employee annuities. The IRS requirements for an employee annuity are as follows:
Qualified employee annuities are funded with pre-tax dollars, whereas non-qualified annuities are funded with post-tax dollars.
If an employee receives annuity payments that have no investment in the contract, those payments are fully taxable.
If an employee withdraws funds before their annuity start date (the day of the first period in which an employee receives a payment) and their annuity is under a qualified plan, a part of the amount withdrawn is taxable.
If an employee withdraws funds on or after their annuity start date, the entire amount is taxable.
For more information, see the IRS Publication 575 for all rules on qualified and non-qualified annuities.
Annuities and 401(k)s are two popular retirement savings options. Though they share similarities (like offering tax-deferred growth), there are key differences you should know to provide the right benefits to your employees.
Here are the main differences between an annuity vs 401(k):
While anybody can purchase an annuity from a life insurance company, people can only have and contribute to a 401(k) if their employer offers one, unless they are self-employed.
Annuities offer guaranteed payment over the course of your lifetime. Therefore, you can’t run out of money during retirement. A 401(k) doesn’t carry as much security; you basically get what you give, plus any investment earnings you receive in the account.
401(k)s carry limits on the amount you can contribute each year. For example, in 2020, the contribution limit amount was $19,500 for those aged 50 and under. There are no limits with annuities, allowing you to put away more money for retirement.
You can borrow money from a 401(k), but you cannot borrow from an annuity.
Although annuities offer a guaranteed stream of retirement income, not many organizations offer annuities as a traditional investment option. For example, a 2017 employee benefits survey reported that only 9% of HR professionals offer in-plan annuities.
This is typically because there are hurdles and complexities employers face with annuities, such as:
Finding an annuity provider that will be around for the long-haul. That way, the provider can pay an employee over the course of their life.
Finding a provider that offers substantial liability protection.
Managing costs involved in factors like moving participants’ investments from one employer to another. This generally entails fees that differ across providers/plans.
While some employers do offer annuities as a central part of their retirement plans (they automatically enroll new employees unless they choose to opt out), the majority are not yet ready to offer annuities to their employees.
Therefore, it’s crucial to dive into research to navigate and negotiate lower investment fees to provide the best possible annuity benefits. If a company’s workforce is large enough, negotiations can be much easier to initiate.