What is an annuity? An annuity is a contract between you and an insurance company to cover specific goals, such as principal protection, lifetime income, legacy planning or long-term care costs. Today, with pension plans becoming less common, many retirees look toward annuities as an option to replace income streams. One may buy an annuity because it does what no other investment can do: provide guaranteed income for the rest of your life no matter how long you live.
An annuity works by transferring risk from the owner, called the annuitant, to the insurance company. Like other types of insurance, you pay the annuity company premiums to bear this risk. Premiums can be a single lump sum or a series of payments, depending on the type of annuity. The premium-paying period is known as the accumulation phase.
Unlike other types of insurance, you don’t pay annuity premiums indefinitely. Eventually, you stop paying the annuity and the annuity starts paying you. When this happens, your contract is said to enter the payout phase.
When an annuity is written properly it can provide…
- Safety – annuitant will earn back principal plus earnings or interest, as long as annuitant pays the premiums
- Tax Deferral – annuitant will not pay taxes until proceeds are withdrawn unlike a CD that earns interest throughout the year and requires a 1099 for tax purposes
- Avoids Probate – annuitant names a beneficiary or beneficiaries and proceeds will go directly to these beneficiaries. This is a specific way to ensure monies go to intended recipients and avoids potential of probate
- Life-time Stream of Income which can outlive the annuitant where the remaining proceeds can go to the intended recipient(s)
- Competitive Interest Rates – much better than a bank savings account or CD