Annuities Explained

Annuities are contracts between individual buyers and insurance companies or mutual fund companies. The concept is straightforward and easily understood. The annuity buyer pays the company a sum of money and the company agrees to pay it back often at a later time.

This can provide a significant benefit for the purchaser by allowing him to defer income from his peak earning years to a later date when he is retired and earning less. It also can reduce the buyer’s tax burden and make his retirement more comfortable and enjoyable. In some respects it can be said that annuity investments create a mechanism by which an individual can purchase an income for later in life when his earning power will be reduced by age and declining health and vigor.

Annuities are available to fill a wide variety of needs in addition to deferring income to a later date such as retirement. Another typical situation arises when an individual receives a lot of money at one time. This can also have an impact on his tax situation, which can be mitigated by an annuity.

Instead of purchasing an annuity with a monthly payment, the entire lump sum can be used as a single payment for an annuity. The annuity buyer can arrange for the company to pay out a lump sum later or he can decide to receive it incrementally when he retires.

Depending upon his tax situation, the buyer may prefer to begin receiving periodic payments on a monthly basis immediately. Although this is not the same as deferring payments until retirement, the buyer may need the additional income such an option can provide. The net impact on his taxes could be considerably reduced by spreading the income out instead of reporting it all at once as a lump sum. There are many companies in the market and a lot of opportunities to compare annuities.

All annuities are contracts, but not all annuities are the same. Two distinct types of annuities are widely offered, fixed and variable. Fixed annuities guarantee that the money in your account will never earn less than a minimum rate of interest and that the payments you receive will never be less than the minimum amount agreed upon in the contract. In a time of economic volatility, fixed annuities offer a welcome stability.

Variable annuities can provide higher rates of interest on your account and more generous payouts. The rates of return and the payments you receive from the company, however, will vary according to economic conditions. A lot of variable annuities will go up and down with the stock market or the S & P 500. They offer greater potential returns but do so at the price of assuming greater risk than the fixed annuity. Variable annuities are also classified as “securities” and regulated at the federal level by the Securities and Exchange Commission. Fixed annuities are not considered “securities” and are consequently regulated at the state level often by insurance commissioners.

As a product, variable annuities include a mix of investment features. Some even include a death benefit like an insurance policy. Both kinds of annuities are contracts, however, and even though the concepts involved are clear and straightforward, any legally binding contract involves a lot of complexity and fine print.

For example, what happens if a financial setback compels you to withdraw your money from the annuity? Can you do it? Is there a penalty for early withdrawal, if so how much? Some annuities allow early withdrawal after a period of five year, or ten years in other cases. Make sure you know what your contract says.

Take the time to compare annuities offered by a wide range of insurance and mutual fund companies. Study the rates of return, penalties, administrative costs and options carefully. Given the competitive nature of the annuity market you can be sure the one you need is out there somewhere waiting to be found.