What is an Annuity?
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.
How Annuities Work
An annuity is similar to a life insurance product, but there are important differences between the two.
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 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.
There are several types of annuities:
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.
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.
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. 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.
Why Annuities Are Important
Unlike an IRA, with an annuity 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.
Annuities are often obtained from a structured settlement of a personal injury lawsuit.