Annuity Life Insurance Policy Definition

Enhance your retirement income with an annuity.

An annuity is a contract between you and an insurance company. If you want to add to your retirement savings, an annuity might be right for you. Intended as a long-term retirement investment, annuities are purchased with an initial premium payment to the insurance company in exchange for regular installment payments, which can begin right away or at some future date. Depending on the type of annuity you purchase, you can structure payouts to suit your personal needs.

Immediate vs. Deferred Annuities

You buy an immediate annuity with a single premium. The payout to you, which begins soon after you pay the premium, is a combination of tax-free return on investment and taxable earnings. You can also purchase deferred annuities, which begin paying out at a specific future date, with a single premium or with scheduled payments to the insurance company. Distributions from a deferred annuity can be spread out over your lifetime, over a fixed amount of time or delivered in a lump sum.

Fixed vs. Variable Annuities

Fixed annuities carry a guaranteed rate of return on your investment. If you are risk-averse, and a sound insurance company backs your annuity, a fixed rate annuity may be best for you. Variable annuities allow for greater earnings, but carry more risk and higher fees and expenses. Because they are subject to the fluctuations of the economy and financial markets, they may not be suitable for older investors.

Expenses

Carrying charges associated with annuities may include initial sales charges, known as front-end load charges, and back-end load fees for early or excessive withdrawal of funds. Variable annuities carry a sub-account management fee in addition to administrative fees. Some insurance companies in some states may also charge transaction charges, annual policy fees and premium taxes.

Benefits

Earnings from a deferred annuity accrue tax-free until they are withdrawn. Generally, there is no limit to how much you can contribute to either type of annuity. Upon your death, the proceeds from an annuity bypass probate and go directly to your beneficiaries.

Considerations

Annuity fees, expenses and early surrender charges can be steep. Contributions to your annuity are not tax-deductible, and you may face penalty fees if you withdraw funds before age 59 1/2. In most cases, you cannot change your distribution payment plan once it is established. Guaranteed payments from your annuity are subject to the insurance company's ability to pay. If, for any reason, the company becomes insolvent, you may not receive your annuity payments.

References

• 360 Degrees of Financial Literacy: Annuities