is a contract between you (the annuity owner or “annuitant”) and an insurance
company. Under this contract, you agree to give the issuer principal and in
return the issuer guarantees you payments over time or a lump
sum pay-out at some future time. While annuities are not insurance policies,
they are issued by insurance companies.
is similar to a retirement plan in that you can fund it in a lump sum or a
little at a time, and all capital in an annuity can grow and compound
tax-deferred until you begin making withdrawals. Unlike retirement plans,
however, there is generally no limit on how much you can invest in annuities. Annuities
can provide tax-deferred growth for lower current income taxes and only an
annuity can provide a guaranteed income stream that the annuitants can’t
There are large number of
available but in fact there are only a handful of different types of annuities. When
selecting an annuity, you will be presented with essentially three choices:
Timing of payout -- Immediate or
deferred: In an immediate annuity, the investor begins to receive payments
immediately upon investing; this is for investors who, for example, want to
receive guaranteed monthly income
payments for the rest of their life. A deferred annuity earns interest on the principal
over a typical term of five to fourteen years before the investor receives
either a lump sum payment or recurring income payments.
Investment type --
variable: Fixed annuities are invested primarily in government securities and
high-grade corporate bonds and they offer a guaranteed rate of return. Variable
annuities enable you to invest in a selection of sub-accounts, such as securities. These sub-accounts are usually tied to stock market performance and
are often invested in a basket of mutual funds. Variable annuities offer the
largest potential for gain but also can decline in value during a down market
Liquidity options -- Most
allow you to withdraw your interest earnings or up to 10% per year of your
principal without a
penalty; although any withdrawal from an annuity may be subject to a
10% federal penalty if taken prior to age 59˝. Most deferred annuities have a
surrender charge -- a penalty for making an early withdrawal above the free
withdrawal amount. Typically the percentage amount of this surrender charge decreases each year
annuities offer the security of a fixed rate along with the opportunity to link
interest rates received to the Dow Jones Industrial Average or the Standard &
Poor’s 500 indices.
When you buy an equity indexed annuity you own an insurance contract; you are
not buying shares of any stock or index fund. An equity indexed annuity credits
interest to your annuity's value using a formula based on changes in the
particular index to which the annuity is linked. The formula determines how the
additional interest is calculated and credited; how much additional interest you
receive and when you get it depends on the features of your particular annuity.
An equity indexed annuity, like other fixed annuities, also guarantees paying a
minimum interest rate that will be applied, at the end of the deferred term, even if the index linked interest
rate is lower. The value of the annuity will not drop below the guaranteed
minimum and the principal that is invested will never be reduced as a result of a decline
in the stock market. Thus, you win when the stock market
goes up and you don't lose when it declines!
In general, an annuity should be considered for its ability to build
tax-deferred earnings from otherwise taxable investments such as mutual funds
and CD's. An Equity Indexed Annuity will permit participation in stock market
gains while protecting the principal from market declines.
several reasons to consider an an annuity because it can provide:
income. An annuity can provide a guaranteed lifetime
income, regardless of how long you live. No other investment instrument can
provide this guarantee.
contributions. Unlike other tax-advantaged investments, such as IRAs, you
can generally contribute an unlimited amount of money to an annuity, whether in
periodic installments or a lump sum.
rates. Some annuities award investors with bonuses --
extra interest that further increases your investment -- at the end of your
annuity's first year. The bonus increases the annuity's principal on which
future interest will be calculated in subsequent years, thus providing a
boost to the ultimate value of an annuity fund.
risk of loss ("fixed" annuities). Unlike investments
in stocks or mutual funds, principal invested in an annuity is not at risk due
to market declines.
annual withdrawals. Most annuities have a provision
that allows you to withdraw up to a certain amount per year (usually 10%) penalty
rollovers. Company pension or profit-sharing plan
payoffs may be reinvested without incurring current taxes or penalties.
probate in case of death, as long as you specify
beneficiaries. Which means your family will find it easier and less costly to
obtain the value of the annuity.
initial sales charges ("no load") or annual fees.
Annuities are generally no-load, no-fee investments, which means more of your
money is actually invested.
investment earnings. Retired people can use annuities
to shelter investment earnings that would otherwise lead to taxation of their Social