Types of Annuities

An annuity is a financial investment that pays out a fixed amount to an investor at regular intervals over the life of the annuitant. It combines a secure income with tax-deferred growth. The annuitant is paid a fixed amount during the course of his or her annuity and receives interest on that amount that is not taxed. Annuity payments are scheduled for a specific period of time and are adjusted for inflation after the retirement date.

When an investor buys annuity insurance, he or she is calculating the present value or discounted value of the annuity payments he or she receives. This process is called computing the discounted annuity factor. This is calculated by dividing the total annuity payments into the variable components and applying a discount rate to the results.

Discounted annuity factors can be derived from many different factors. The two most common ways to derive them are from the statistical data of past years and from the performance of structured settlements. A company’s financial performance has a large effect on its discount rates. That is why most structured settlement buyers purchase their payments from factoring companies.

Compute the present values of annuity payments annually using the following formula:

Yield Spread Premium (YSPC) is the premium paid for selling a contract in a single transaction. The selling price less the commission charged by the broker (X), less the discount rate (Y), less the cash surrender value (Z) less the YSPC, less the cash return (R). Discount rate less the YSPC is the present value (PV) of selling a contract at the purchase price less the cash surrender value (Z). Cash return less the cash surrender value is the amount realized on a one-time basis when one sells a annuity to a buyer. The Present Value of an Annuity is the amount received today less the amount realized on a one-time basis.

Sometimes the present value is less than the discounted value because the buyer will surrender the annuity before the coupon payment is made. In that case the buyer will receive interest on the surrendered amount less the YSPC. YSPC is the excess of the present value over the discounted value.

If you buy a note for a profit, the annuity is purchased in order to resell the note to a third party. You make the initial investment and in turn buy notes from investors. You then resell the notes to investors making a profit. When you reach a point where you will be paying interest on your invested funds rather than collecting rental income from tenants, then you sell your annuity payments for a profit. You may choose to reinvest the proceeds from the sale into additional notes or purchase additional property to place n additional notes on.

With an Annuity Sales Tax deferred until dispersal, the purchaser receives immediate distribution without paying taxes on the distributions. The deferred tax is reported on Schedule C. The proceeds from the sale of the deferred annuity are subject to UBIT, which is described below. UBIT is the sales price of the deferred annuity divided by the sales price of the annuity in order to give the purchaser a profit. If the sale occurs within the defined period within which a distribution is taxable, then the tax is deferred until that distribution occurs. Otherwise, the tax is incurred when the purchaser receives the payment.

PV: The term “PV” stands for “value of a percent.” The higher the percent, the larger the payments are deferred until distribution. A percentage of the loan amount is paid to the purchaser and the remaining portion is left as a loan to be repaid. When purchasing an annuity with this type of sale, the seller is not required to provide any upfront investment, but instead must agree to repayment of the loan in one lump sum.