What is an Annuity
Annuity is a fixed amount of money paid over fixed period of time. It is a type of financial product. In the US, it is a financial product where insured person pays a single premium to Life Insurance Company. This premium amount is paid back to insured party after a specified period, say after 10 years in small amounts for a fixed period, mostly monthly or annually.
Annuity can be categorized into immediate and deferred. Immediate annuity has three sub types – Life, life variants and specific period annuity. Life annuities are paid to the insured at a very later stage of life. It is based on the fact that probability of living of insured is higher. The main motive is to save money for later part of life when the regular source of income is called off due to retirement.
Immediate annuity is used to get pension income. The life insured pays premium for a certain period and then company pays back those premium amounts till the survival of the life insured or even after that to the surviving nominee. Specific period annuity is used to meet requirements which are supposed to be ending with the end of the period of the annuity contract.
Proper planning and vision is required to get the maximum benefit from the annuity. Annuity contracts in the United States are governed by Internal Revenue Code. Only life insurance companies are authorized to issue annuity contracts in US.
Annuity contract has two phases – one in which insured life makes payments to an account and in other part benefits of savings made are to be reaped. Contract can be structured in such a manner that there is only annuity part existing. This is made possible by making single premium payment. This premium deposited is sure to return to the customer in the form of deferred payments received over a period of time ranging from ten years to till the end of life.
Deferred annuity contract is made to ensure accumulation of savings which can be withdrawn later either as lump-sum or in the form of small payments received in regular intervals. Deferred annuity can be of fixed nature and of variable nature as well. Deferred annuity of fixed type shows growth in amount due to interest earnings only. Variable annuity is composed of earnings made by investing money in bond funds and stock market.
The profit earned in the case of deferred annuity is not taxable as long as it lies accumulated. Capital gains and ordinary income is taxed only at the time of withdrawal. Deferred fixed annuity guarantees assured return to the investor fixed at as low as typically 3%. Variable deferred annuities are preferred by those investors who want to invest in tax-deferred options.