What Is It?
You can think of an annuity as another way of saying "annual payments". An annuity is a series of fixed-amount payments paid at regular intervals over the specified period of the annuity. Most annuities are purchased through an insurance company.
A "deferred" annuity means that the series of annual payments will not begin until a later date. This is popular with retirees because they can defer taxes until annual payments are received. An "immediate" annuity means that the income payments start right away. Some annuity contracts are good for life, so if you live long, then the insurance company must continue to pay you. The insurance companies are basically betting that you will die before the full value of the annuity is paid out.
There are two distinct types of annuities:
Fixed Annuity: This means the insurance company makes fixed dollar payments to the annuity holder for the term of the contract. This is usually until the annuitant dies. The insurance company guarantees both earnings and principal. This is a fairly good financial instrument for those looking to receive a fixed investment income.
Variable Annuity: This means that at the end of the accumulation phase the insurance company guarantees a minimum payment, and the remaining income payments can vary depending on the performance of your annuity investment portfolio. Annuities allow you to invest in a managed portfolio of stocks, bonds, money market funds, or any combination thereof. The performance of this portfolio determines the annual payment you will receive.
Objectives and Risks
Annuities are often forgotten by individual investors, partly because people are unaware of their benefits. Annuities are advantageous for those looking for a relatively low-risk investment with a decent rate of capital appreciation. Deferred annuities allow you to enjoy the benefits of compounding without worrying about the tax implications.
The risks involved with annuities are fairly small compared to those of other investments because your investment is heavily regulated by the government. It is a good idea to ask the company from which you purchase an annuity if the company is insured - not all of them are. One precaution: annuities allow you to withdraw your principal, but you may be subject to stiff penalties.
How to Buy or Sell It
Annuities are offered by most insurance companies, banks and brokers. The minimum investment for an annuity is typically $1,000 plus purchase fees. These fees can range from a load to an annual management fee that can be a maximum of 1.5% of your total investment.
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