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What Are Annuities?

Annuities are popular options for retirees to receive a steady stream of income throughout the rest of their life. Yet researching annuities can be a daunting task. The keyword “annuity” fetches 13,100,000 hits on Google Search! An investor should give up on the idea of annuities as something too complex or confusing to bother with. There are many good resources out there, and a credible bank or insurance company is a good place to start looking for information. Not all annuities are the same, and each type provides different benefits and risks to investors.

What Are Annuities, Actually?

An annuity is an agreement between an insurance company and the person buying the annuity. The buyer pays the insurance companies either periodic installments or a lump sum of cash. In return, the insurance company promises to make payments to the buyer or one of their beneficiaries after a certain, pre-specified date. All interest earned in an annuity is tax deferred. This allows money invested in an annuity to grow faster than it would in a taxable account.

There are several types of annuities, including fixed annuities, variable annuities, index annuities, and long-term care annuities.

A fixed annuity earns a fixed interest rate so that the money grows in value, much like a bank account. The insurance company guarantees fixed dollar amount payments from the account. If the payments are for the investor themselves, they may last for a designated period or for the rest of their life.

A variable annuity allows the buyer to choose how their money is invested, either in stocks, bonds, or mutual funds. The amount of money they receive in payouts in the end depends on how well their investments did. Variable annuities are regulated by the Securities and Exchange Commission (SEC).

Index annuities are much different. They are tied to how the stock market performs. The buyer makes monthly payments or a lump sum deposit into their annuity and the insurance company gives them a return that is dependent on changes in the Dow, NASDAQ, or S&P 500. After the acclimation period, the payouts begin. Payments can be made monthly, quarterly, annually, or all at once in a lump sum.

Long-term care annuities provide more money over a shorter period of time than other annuities, and are meant to pay for health care expenses. The payout time lasts for 2-3 years. Buyers may choose to purchase additional coverage for another 2-3 years or even the rest of their life.

Money cannot be withdrawn from an annuity during its growth phase without penalties. There is a 10% penalty imposed by the tax code on any money taken out of a tax deferred annuity before the age of 59 ˝. Insurers also charge fees and penalties if the money is withdrawn within the first 7 years.

Why Use An Annuity?

Annuities provide their owners with a constant income stream and are especially useful during retirement. One might choose to invest in an annuity to help them save for a long-term financial goal.

An annuity can also be set up in a child’s name and begin payments when it’s time to pay for college expenses. It is important to note that the money would be taxed and could be penalized when withdrawn. In addition, there is nothing to guarantee that the beneficiary uses the money to pay educational costs.

Many retirees consider something called an immediate annuity. This allows them to deposit their retirement plan payout as a lump sum, and then get periodic payments from it for the rest of their life from the insurance company. While this does ensure income for life, there are a few things a retiree should be aware of. First, payments are fixed and don’t adjust for inflation. Second, the remaining balance at the time of death is not transferred to dependents.

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