An annuity is a financial contract written by an insurance company that provides for a series of guaranteed payments, either for a specific period of time or for the lifetime of one or more individuals.
Although an annuity is essentially a life insurance product, there are important differences between the two.
For example, under the terms of a life insurance policy the insurer will generally make a payment upon the death of the insured. Under the terms of an annuity, however, the insurance company makes its payments during the lifetime of the individual.
In addition, unless the annuity contract specifies a beneficiary, most annuity payments cease upon the death of the recipient.
The Key Benefits of Annuities include:
- Earnings grow tax-deferred until withdrawal.
- Annuity holders receive a specified amount of annual income during retirement.
- Investors are allowed to switch between investments in their annuity tax-free.
- Investors can contribute as much as they want during the accumulation phase of an annuity.
Because of the various needs and motivations of annuity holders, insurance companies have developed a wide variety of flexibility and variation in annuity contracts. Below you will find a brief analysis of some of the options available to you.
Types of Annuities
There are two basic types of annuities: Immediate and Deferred.
Immediate Annuities are usually purchased at retirement age, with benefits that begin immediately (within one year of purchase).
Deferred Annuities offer benefit payments that begin at some future date. Interest usually accrues on a tax-deferred basis in the interim.
Annuities are also classified as either “Qualified” or “Non-Qualified’ based on the type of funds that an investor uses to purchase the annuity contract (or to contribute to it).
Qualified Annuities are annuities that an investor funds with either pre-tax dollars or tax-deductible contributions.
Non-Qualified Annuities are those contracts funded with after-tax dollars.
Annuities may also be Fixed or Variable.
A Fixed Annuity is a personal retirement account in which the earnings are based on a fixed rate set by the insurance company. Fixed annuities are susceptible to inflation risk due to the fact that there is no adjustment provided for runaway inflation.
A Variable Annuity is a personal retirement account in which the investment grows tax-deferred until the investor is ready to withdraw the assets. Unlike an IRA, there are no restrictions on the amount of the annual investment.
In addition, variable annuities offer the potential for greater returns and the opportunity for the investor to make his/her own decisions regarding how the assets are invested.
Another important feature of the variable annuity is the family protection, or death benefit, that often comes along with such contracts. This guarantees that, should the investor die during the accumulation phase of the variable annuity, the account owner’s beneficiary will receive at least the amount of the investor’s contributions minus withdrawals, or the current market value of the account.
The Investing Answer: Annuities have become much more attractive investment options for retirement savings in recent years. This has been due in large part to innovation within the industry, as providers have introduced reasonably priced products with greater flexibility, as well as a variety of investment options.