Definition
An Annuity is a financial product that involves a series of equal periodic payments or receipts made at regular intervals, either over a specified number of years or for the lifetime of the individual. There are different types of annuities, including fixed, variable, immediate, and deferred annuities. The primary purpose of annuities is to provide a steady income stream, making them a popular choice for retirement planning.
Examples
- Fixed Annuity: An insurance company agrees to pay an individual $500 per month for the next 20 years.
- Variable Annuity: An individual invests $10,000 in a variable annuity, where the payments vary based on the performance of underlying investments.
- Immediate Annuity: A retiree pays $100,000 up front to an insurance company, which in turn, begins paying $8,000 annually for the rest of the retiree’s life.
- Deferred Annuity: A person invests $5,000 annually in a deferred annuity for 15 years. The payout will commence once the individual turns 65.
Frequently Asked Questions (FAQs)
What is the difference between an ordinary annuity and an annuity due?
- Ordinary Annuity: Payments are made at the end of each period (e.g., at the end of each month or year).
- Annuity Due: Payments are made at the beginning of each period (e.g., rent payments that are due at the start of the month).
Are annuities taxable?
Annuities are subject to different tax rules depending on the type. Generally, annuity payments are taxable as income in the year they are received. If the contributions were made with pre-tax dollars, the entire annuity payment is taxable. If made with after-tax dollars, only the interest earned is taxable.
Can I withdraw money from an annuity before retirement?
Yes, but early withdrawals from an annuity often come with penalties and surrender charges. In addition, withdrawn amounts might incur regular income taxes and a possible 10% early withdrawal penalty if the owner is under 59½ years old.
How does a variable annuity differ from a fixed annuity?
- Fixed Annuity: Provides consistent, guaranteed payments based on a fixed interest rate.
- Variable Annuity: Payments vary depending on the performance of investments chosen by the holder, allowing for potentially higher returns but also more risk.
Are annuities a good investment?
Annuities can be a good investment for those seeking guaranteed income, especially in retirement. However, they may come with higher fees and less liquidity compared to other investment options. It is essential to consider one’s financial goals and consult with a financial advisor.
Related Terms
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Annuity Due: An annuity where payments are made at the beginning of each period.
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Immediate Annuity: An annuity where payments begin almost immediately after a lump sum is invested.
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Deferred Annuity: An annuity where payments begin at a future date, allowing the invested funds to grow.
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Fixed Annuity: An annuity that provides guaranteed payouts based on a fixed rate of return.
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Variable Annuity: An annuity where payouts are based on the performance of invested funds, thus varying over time.
Online Resources
References
Suggested Books for Further Study
- “The Annuity Handbook” by Lowell Aronoff
- “The Advisor’s Guide to Annuities” by Michael E. Kitces
- “Annuities for Dummies” by Kerry Pechter
- “The Retirement Income Frontier: A Guide to Evaluating Retirement Income Solutions” by David C. Babbel and Craig B. Merrill
