What Is Investment in the Contract?
Investment in the contract as applied to annuities is the principal amount the holder has invested. It can be made by payments or a lump sum. This term generally applies to fixed, indexed and variable annuities alike.
Understanding Investment in the Contract
Any amount of money withdrawn from an annuity that is in excess of the investment in the contract is considered a taxable distribution. Investors who annuitize their contracts will see a portion of each payment they receive classified as a return of principal or investment in the contract. This portion of each payment is considered a tax-free return of principal.
An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income stream for retirees. Annuities are created and sold by financial institutions, which accept and invest funds from individuals and then, upon annuitization, issue a stream of payments later.
Annuities can be created so that upon annuitization, payments will continue as long as either the annuitant or their spouse, if a survivorship benefit is elected, is alive. Annuities also can be structured to pay out funds for a fixed period, such as 20 years, regardless of how long the annuitant lives.
Also, annuities can begin immediately upon deposit of a lump sum, or they may be structured as deferred benefits. Annuities were designed to secure steady cash flow for an individual during their retirement years and to alleviate longevity risk, or outliving their assets.
An annuity contract is a written agreement between an insurance company and a customer outlining each party's obligations. It includes details such as the structure of the annuity, whether variable or fixed, any penalties for early withdrawal, spousal and beneficiary provisions, such as a survivor clause and rate of spousal coverage, and more.
An annuity contract may have up to four counterparties: the issuer, usually an insurance company; the owner of the annuity; the annuitant; and the beneficiary. The owner is the contract holder. The annuitant is the individual whose life is used as the yardstick for determining when benefits payments will start and cease. In most cases, the owner and annuitant are the same person.
The beneficiary is the individual designated by the annuity owner to receive any death benefit when the annuitant dies. An annuity contract is beneficial to the individual investor in that it legally binds the insurance company to provide a guaranteed periodic payment to the annuitant once the annuitant reaches retirement and requests commencement of payments. Essentially, it guarantees risk-free retirement income.