In the news, almost daily, there is more and more talk about annuities. So what exactly is an annuity?
Simply, an annuity is an agreement (contract) between an organization (insurance company) to pay another an agreed upon benefit. The benefit can be in the form of periodic payments or a lump sum. Annuities are issued by insurance companies and are regulated by state and generally federal laws.
Life Insurance companies issue annuities and are contractually guaranteed by the insurance company and most life insurance companies sell annuities. A deposit is made to an insurance company either lump sum or periodic payments. The type of annuity you choose determines whether your money earns a fixed amount (interest or fixed indexed) or an amount that depends on market volatility in equities and bonds. (variable annuity) At a designated time chosen by you the insurance company will send you regular distributions from the annuity’s account, the term of the payment can even be for lifetime, regardless of how long you live. Other options can include to leave your funds intact and never touch them or to remove your funds in a lump sum.
Annuities have numerous benefits but an important one for many people who choose an annuity is the tax deferral aspect of the contract. The interest earned in an annuity grows tax deferred until it is removed. The interest is credited to your annuity and the tax liability is deferred.
There are several different kinds of annuities. Some of the more common types of the annuities:
- Single premium immediate annuity: You deposit with an insurance company a lump sum now and begin to receive withdrawal distributions for a period of time you specify. The amount you receive will vary according to the length of time the payments are to last and whether anyone will receive the remaining balance at your death.
- Single premium deferred annuity: You deposit with an insurance company a lump sum now and defer receiving withdrawals until later. The amount of those distributions will depend on the value of your account at the time your payments begin, the length of time the payments are to last, and whether anyone will receive the remaining balance at your death.
- Annual premium deferred annuity: You deposit money with the insurance company usually monthly, quarterly, or annually. Your money earns interest and you defer your withdrawals to a later date.
There are many categories and many reasons to consider an annuity. They can be classified by:
- Nature of the underlying investment – fixed or variable (securities)
- Primary purpose – accumulation or pay-out (deferred or immediate)
- Nature of pay-out commitment – fixed period, fixed amount, or lifetime
- Tax status – qualified or nonqualified
- Premium payment arrangement – single premium or flexible premium
Numerous other benefits can be provided with the contractual guarantees of an annuity. These benefits can include:
- Avoidance of probate with the funds being delivered immediate and without delay to a named beneficiary.
- Income options exist to provide numerous choices in how and for how long to receive funds. Lifetime income is always an option and is generally available on all annuity contracts.
- In some states, the proceeds from an annuity are protected from creditors. The rules governing this protection vary from state to state.
- Safety and security (guaranteed against market risk) is a solid reason for considering an annuity. Numerous guarantees are in place to assure the annuity owner that their funds are guaranteed.
When considering an annuity make certain you fully understand the contractual features of the contract including any surrender penalty period and how the interest (yield) is calculated. Selecting an annuity depends on matching the benefits it provides with your intended goals.