An Annuities Explanation

It is easy to become confused about the exact nature of annuities. Explanations of annuities tend to focus on the types available, without providing an overview of the plans.  In general, a bank’s Certificates of Deposit are similar to annuities. An annuities explanation follows, broaching how they work and what you should consider before choosing an annuity product.

The word “annuity” comes from the Latin “annus,” which means “year.” An annuity is a contract between an insurance firm and an individual under which the individual makes a series of payments, and in return, the insurer promises to provide payments – with interest – to the individual after some specified future date. In this way, an annuity provides for earnings growth on a tax-deferred basis. Most people purchase annuities to provide them with income after they retire.

Annuities differ from life insurance, health insurance, or savings accounts. Annuities are long-term contracts and are not designed to provide short-term resolution to financial needs. And tax-deferred annuities mean that individuals cannot withdraw money from the plans before a certain age without incurring a penalty.

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Annuity Categories

There are several categories of annuities, which are based on various elements, such as interest rate or payment terms. For example, an annuity can be arranged so that the annuitant – the owner of the annuity – will receive payments for as long as he or she, or his or her spouse, is alive. In another example, an annuity can be structure so that the payouts continue for a specifically defined length of time, e.g. 20 years.

Annuities may be either fixed or variable. With a fixed annuity, annuitants are guaranteed a certain payout amount. Variable annuities involve a variable interest rate and therefore have the potential to provide higher returns.

Insurance companies provide variable annuities for sale through agents and brokers. The insurer places money invested in annuities into sub-accounts. These accounts are often invested in mutual funds, which then invest the monies in stocks. This makes a variable annuity something of a hybrid plan, which contains some elements of insurance and some of investment securities. Variable annuities can be purchased either with a single payment or a series of several payments. And the value of the ultimate payout depends on how the money is invested.

Before You Buy

Before purchasing a variable annuity, define your long-term goals and how long you are willing to put your money beyond the reach of your immediate needs. Be sure to ask about any fees and expenses associated with the plan, and if you are promised a guaranteed return, get that promise in writing from your agent or broker.

It is critical that investors consult knowledgeable financial planners before purchasing an annuity.

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