There is so much mystery surrounding annuities and what they can do for you. What are they? Who should by them? What kinds are there? In a nutshell, an annuity is an investment instrument sold by insurance companies that provide the owner with regular payments over a period of time. Annuities have often part of a retirement plan.
Annuities are a popular retirement option because earnings from the annuity are tax-deferred until they are withdrawn. Annuities are sold in two basic forms fixed and variable.
Fixed annuities are interest-based investments similar to certificates of deposit (CDs). Usually, the purchaser makes an initial deposit from $5,000 to $1,000,000. At the time of purchase, the interest rate and the holding period are locked in. As an investment, fixed annuities are low risk. In addition, they are more liquid than CDs.
Purchasers can choose between two types of distribution: immediate or deferred. With an immediate distribution, the purchaser begins getting monthly payouts immediately. Payments continue until the principal and interest are exhausted. If the purchaser chooses a deferred distribution, then payments begin at the end of the term. So if the deferred annuity had a ten-year term, payments would begin at the end of the 10th year.
Variable annuities are also offered by insurance companies. They differ from fixed annuities in that they are typically based on mutual funds. Variable annuities offer periodic payments for the rest of your life. In addition, they have a death benefit.
Variable annuities have two phases: accumulation and payout. In the accumulation phase, you allocate purchase payments to a variety of investment options. Your account balance will depend on each fund’s performance over the years. During the payout phase, you can choose to take the total investment plus gains as a lump sum, or at regular monthly, quarterly, or yearly intervals.