What are Annuities?

For financial security in retirement, more and more people are including annuities in their financial planning. Then what are annuities?

What Are Annuities?

An annuity is a financial insurance contract that provides a periodic payment of income over a long period of time. But an annuity is not a life insurance. It is designed to help you accumulate money for your retirement income needs and pay benefits while you are living. In contrast, a life insurance policy provides benefits to your beneficiaries when you die.

Be careful not to confuse annuities with IRAs. Many insurance companies refer to an IRA as an individual retirement annuity. Keep in mind that an annuity is a kind of investment option in which you may invest traditional or Roth IRA funds. An individual retirement annuity is a contract set up by purchasing an annuity from a life insurance company.

However, if you use IRA accounts just to defer income taxes, it makes little sense to hold annuities within your IRA accounts. That's because one of the main advantages of an annuity is that your money grows tax-deferred. So the annuity's investment earnings can accumulate and compound until you begin to withdraw. Hence, it is important to understand the main characteristics and features of annuities before placing them within IRAs.

For better understanding of annuities, you need to begin with the basics.

• Is an Annuity Right for You? To find out the answer, you need to think about your financial objectives and risk tolerance. Following questions may help you determine whether an annuity would benefit you.
• What will be your retirement income sources?
• How much will you need for your retirement income in addition to other income sources?
• When do you plan to retire? In other words, when do you expect to withdraw money from your retirement saving accounts?
• How long do you want your retirement income to last even though you don't work after retirement?
• Do you want your spouse to receive income after your death?
• In case of an emergency, do you have any other investments or savings accounts that can be quickly converted to cash?
• What investment options are you familiar with? Do you know your risk tolerance?
• Type of Annuities by Premium option
• Single Premium Annuity This is a contract that requires you to pay the entire premium up front in one single premium. You cannot add additional premium to the account.
• Multiple Premium Annuity This type of annuities allows you to make a series of premium payment over time.
• Type of Annuities by Payout option
• Immediate Annuity If you want to begin to receive income payments no later than on year after you pay the premium, you can buy an immediate annuity.
• Deferred Annuity If you want to accumulate money during the working years and begin to receive income many years later, you can buy a deferred annuity. No taxes are owed on the credited interest until the payments begin.
• Type of Annuities by Investment option
• Fixed Annuity A fixed annuity generates earnings at a current interest rate set by the insurance company or in a way specified in the annuity contract. The issuing company guarantees that it will pay no less than a minimum interest rate.
• Variable Annuity A variable annuity provides a non-guaranteed benefit amount that varies, depending on the gains and losses on investments underlying the contract.
• Equity Index Annuity An equity index annuity combine characteristics of both fixed and variable annuities. Its returns are based on the performance of a market index, such as S&P 500, but it guarantees a minimum interest rate.
• Fees and Charges When you buy annuities, particularly variable annuities, you should be aware of fees and charges that may eat away at the value of your investment.
• Mortality and Expense Charges
• Surrender Charges
• Management Fees
• Tax Rules Even though annuities generally allow your investment to grow tax-deferred, you should be aware of certain tax rules before you purchase an annuity.
• Death Benefit If you die before the payout period starts, the contract value will be paid to your beneficiaries. The death benefit works differently depending on which kind of contract it is. Some variable annuities provide that the benefit will be at least the total amount invested, even if the account has lost money.
• Glossary of Terms