Annuity payments provide secure annual income
In the United States, an annuity contract is issued by a life insurance company. According to the terms of the contract, the recipient gives the insurance company money, which can accumulate interest at tax-deferred rates, and the issuing company agrees to repay that money, plus accrued interest, in annual installments.
Types of Annuities
Insurance companies offer highly variable annuity products. Some terms you should familiarize yourself with if you're interested in annuities include:
- Immediate annuity. An immediate annuity is an insurance policy that guarantees the policyholder will receive a series of payments from the issuer in exchange for an initial investment. These payments can be issued over a fixed period (for example, five years) or annually for the lifetime of the policyholder.
- Fixed annuity. Fixed annuities are paid at a fixed interest rate. These are advantageous when interest rates are high and expected to drop over the life of the annuity, as the policyholder will continue to enjoy the high rate even after centralized rates are lowered. In other words, with fixed annuities, your annuity rate won't be affected by fluctuations in interest rates.
- Variable annuity. Conversely, a variable annuity has a shifting interest rate, which is usually tied to the prime rate offered by the U.S. government. These are advantageous when interest rates are low and expected to rise.
- Deferred annuity. A deferred annuity is one whose payments are dependent upon the performance of the separate accounts the issuer invests the policyholder's upfront lump-sum payment in. These accounts are professionally managed. While a deferred annuity poses inherent risk, it also has the potential to be very profitable. Also, any financial accumulations in the separate accounts are not taxed until actual annuity payments are dispersed.
- Structured settlement annuity. A structured settlement annuity is a financial product in which the insurance company agrees to pay the policyholder a fixed, annual lump sum if the policyholder meets with a specifically defined, debilitating accident.
Advantages of Annuity Investments
A retirement annuity is a sound investment for many reasons. Not only does it provide a secure means of regular income in your retirement years, it also adds variation and stability to your investment portfolio. Even if your other investments perform poorly, you can count on your retirement annuity to pay you like clockwork.
The tax-deferred growth also helps you make the most of your initial investment without having to worry about capital gains or other taxations. You also pay taxes only on the amounts paid out to you rather than the entire value of the investment, which also saves you money in the long run.