Insurance companies offer annuities, a type of tax-sheltered pension plans, as an option for retirement savings. Participants contribute to annuities in exchange for future payments -- called annuities -- to the retiree or, if applicable, to survivors. Although individuals may enter into annuity contracts with insurers, group annuity contracts are between insurers and employers that limit participation to their eligible employees. The group annuity, called a “structured pension plan” by the Committee of Annuity Insurers, began in the 1920s -- before Social Security -- to provide income for retired workers.
Under Internal Revenue Service rules, a group annuity is a defined-benefit plan. It guarantees a pension benefit to qualified participants, and it defines how that benefit is calculated, and how long and to whom it will be paid (Ref 4). An employer establishes a group annuity on behalf of its employees by signing a master contract with the insurer. This contract details the agreement between the insurer and employer -- such as plan type, contribution requirements and administrative fees. The group annuity plan outlines the requirements for employee eligibility and participation. Early group annuity contracts usually required contributions from both employer and employees while they were working at the company.
Employers choose one of three types of group annuity contracts, which offer varying degrees of cost-control and financial benefits. A company that signs a contract for a deferred group annuity makes periodic payments, which the insurance company uses to purchase deferred annuities for the covered employees. A deposit administration contract, which provides retirees with a fixed annuity, allows employers more flexibility in making payments. It includes cost-control measures and requires the insurer to assume the risk of employee mortality and turnover rates. The immediate participation guarantee contract, the newest of the three types, links more elements of pensions to employee mortality rates and returns on investments.
A group annuity participant has a few choices, depending on the type of plan the employer offers. Common to annuity plans is the choice of a lump-sum payment or periodic payments over the retiree’s lifetime. Participants also may choose a life annuity payable only during their lifetimes, or a joint life annuity that's payable after the retiree’s death to a surviving spouse. Plan rules often allow an employee who leaves the company to choose between a lump-sum withdrawal of her contributions or receiving periodic payments when she retires.
Many employers have been winding down their group annuity plans and closing them to new participants. Defined-contribution plans, the preferred retirement plan type, have largely replaced defined-benefit plans such as group annuities. Contributions are the focus of defined-contribution plans, which offer no guaranteed benefit. Retirement savers have more choices for moving retirement funds between employer accounts and personal retirement savings accounts. However, the group annuity is gaining new life in hybrid plans. Some employers offer the group annuity in combination with defined-contribution plans such as 401(k)s.