What is an Annuity?
A SIMPLE WAY TO UNDERSTAND ANNUITIES
An annuity takes money that has been earned on an investment and distributes it to the beneficiary at predefined intervals (e.g. quarterly, semi-annual, annual payments). For instance, they can be incorporated as a part of a retirement plan and offer you supplemental income. There are various types to consider including income-based, lifetime-based, or lump sum. Fixed or variable distributions can be arranged.
THEY’VE BEEN AROUND FOR MORE THAN 200 YEARS
Annuities been around for more than 200 years. In the mid 1700′s the Presbyterian Church used them to provide security for the clergy and their surviving spouses. Retirement annuities provide the ability to accumulate tax-deferred funds for retirement and receive a guaranteed income for a specified period of time. The “lifetime income” option is a popular choice for retirees. Sometimes these annuities are referred to as personal pension plans. They provide fixed monthly payments, as opposed to stock-based pension plans that offer no guarantee of return.
With the fixed payment option, a set amount is guaranteed in each payout. In the case of a variable annuity, the payments fluctuate based on the performance of the underlying investment. This means payments could be smaller when the financial markets are weak. Fixed annuities, on the other hand, are have a varying rate of return based on the company they are associated with.
Annuities can tend to be confusing to many - it doesn’t seem to make sense that they can generate income no matter how long the owner lives, despite their having paid a fixed number of premiums. As with other life insurance products, annuities are based in great part on actuarial tables which predict average life expectancy. These tables help determine the product’s premiums and disbursement schedules. It may be difficult to understand the different types of annuities, especially when deferred, indexed, immediate, and variable options can vary so much in structure. Depending on your financial goals and income requirements, they can be structured to provide retirement support during the investment phase while also growing tax deferred. Because of this, some people think of annuities as investment instruments. But the primary goal is to provide a stable income, usually for retirement purposes.
THE PRIMARY BENEFITS OF ANNUITIES
Retirement annuities are unlike any other investment vehicle. Their key purpose is to provide immediate income for life with tax deferral and repayment guarantees.
Fixed or variable contracts (chosen based on the owner’s risk tolerance) allow you to invest underlying capital on a tax-deferred basis with the potential of earning higher-than-average returns. An annuity should be considered a portion of an investment portfolio or stable retirement plan.
Retirement annuities are backed by larger insurance companies. The company must be scrutinized and licensed by individual states (as do the planners that provide these products). The insurance commissioners from each state evaluate the insurance company to guarantee they have reserve money to back up the investment. This is known as the State Guaranty Fund. It is an extra layer of protection provided for investors. This Guaranty Fund is different in each state and can be as high as a half million dollars. A quick word of warning – this protection exists for fixed-rate annuity holders only. Variable annuities are excluded from State Guaranty Fund protection.