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Annuity Products |
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Group Annuities
Corporations (or other business entities) may find annuities to be helpful in meeting their obligations. The most common corporate use of annuities is to fund and distribute pension payments to their retirees. This was the initial reason issuers developed group annuities. Prior to the development of modern group annuities in the early 20th century, pension plans were a pay-as-you-go pension scheme, which primarily benefited corporate executives. Corporations would simply pay benefits to retired executives out of current earnings. Group annuities allowed corporations, in exchange for premium payments, to shift that responsibility as well as the investment and mortality risk to insurance companies. This also allowed for the expansion of retirement benefits to more rank-and-file employees — either paid fully by the employer, or through employee contributions. These group annuities provided a fixed retirement benefit usually based on the number of years of service.
Qualified Plans
When federal pension laws were reorganized under the Employee Retirement Income Security Act (ERISA) in 1974, traditional pension plans, were reclassified as defined benefit plans. As the label suggests, the benefit is "defined" (i.e., fixed by some sort of formula). ERISA mandates that defined benefit plans purchase insurance coverage from the Pension Benefit Guaranty Board (the cost of which has increased over the years). ERISA also imposed greater accounting and funding requirements on defined benefit plans to assure that companies would have adequate funds available to meet its obligations. Plans that purchase an annuity to guarantee funding are exempted from many of the additional costs of these new regulations. As a result, ERISA motivated many defined benefit plans to become "annuity purchase plans", creating a large market for group annuities. In these traditional annuity purchase plans, the group annuity serves as a vehicle to accumulate pension funds during the employee's working years, and eventually as a distribution vehicle to pay the defined benefits.
As life expectancies lengthened, the legacy costs promised to retirees increased. In the last decades of the 20th century, many companies shifted from defined benefit plans to defined contribution plans. Instead of guaranteeing a fixed benefit to retirees, companies chose to guarantee a fixed contribution to the pension fund. The fund would eventually pay retirement benefits based on employer and employee contributions, plus investment income generated by the plan's portfolio. Initially, such plans were "money purchase" plans. Money purchase plans essentially hold a portfolio of investments for benefit of the employees as a group and are managed by the corporation as a trustee. Over time, individually tailored plans such as 401(k) plans became more popular — monies are be deposited into an employee's individual account and the employee directs the fund's investments. (Tax Sheltered Annuities, or TSAs, serve the same role for non-profit employers.) Regardless of the size and type of the account, all defined contribution plans shift the investment risk from the employer to the employee. Annuities, especially variable annuities with their separate accounts, are commonly used to meet the accumulation needs of the defined contribution plan. Even in those cases where the corporate trustee directly manages the investments in the plan, annuities may be an ideal vehicle for distribution of benefits to retired employees. Companies with defined benefit plans can use a portion of the investment fund to purchase an individual annuity to pay benefits for each retiree, or the company may opt for a group annuity to cover all of the company's retirees. The retirement benefits can be paid out as a guaranteed fixed annuity (subject to inflation risk), or based on the investment results of a variable annuity's separate account (subject to investment risk).
In general, monies contributed to qualified annuities are tax-deductible, the earnings grow tax-deferred and eventual payouts to retirees are fully taxed as ordinary income in the year the monies are received.
A 1982 amendment to ERISA mandates that retirement benefits paid to married workers must be paid in the form of a joint annuity, unless the worker's spouse waives that requirement in writing. This requirement, designed to protect widows and widowers from having their income cut due to the death of the covered worker, encourages the use of commercial annuities as a distribution vehicle for retirement benefits.
Separate accounts holding the investment portfolios of a variable annuity are typically registered with the SEC under the Investment Company Act. Some group variable annuity contracts are exempt from that registration requirement. Group variable annuities that are sold exclusively to qualified retirement plans need not register. This exemption applies only to plans covering at least 25 employees in which the employees make no contribution to the purchase of the annuity. Variable group annuity contracts may be issued under other conditions, but they must be registered under the Investment Company Act.
Non-Qualified Plans
While qualified retirement plans represent a large market for annuities, corporations can also use annuities to fund non-qualified retirement programs, such a deferred compensation plans. Non-qualified plans do not need to meet the strict rules of ERISA and can be offered to a select group of “key” employees. Non-qualified plans can be an inducement in hiring new personnel, or they can be used as “golden handcuffs” to retain employees who are critical to the company’s success. In a non-qualified deferred compensation plan, the employee will forgo some of his or her current, taxable compensation in return for a promise of greater retirement benefits. The idea is to defer paying taxes on today’s income and receive it in the future, presumably when the retiree is in a lower tax bracket. The employer can use the deferred compensation to purchase an annuity contract to fund and pay the promised retirement benefits.
Florida’s Senior Suitability Law applies to individual annuity contracts as well as group annuity contracts that are individually solicited (as can be the case with many IRAs, 401ks and TSAs). Group annuities sold to employers to cover their collective retirees are exempt from the Senior Suitability Law. Annuities sold to employers to fund non-qualified deferred compensation plans are also exempt from this law. |
