What is the Purpose of an Annuity?

Providing a secure financial future means more than saving enough money to build up your 401k. The 401k is nothing but a retirement savings plan sponsored by an employer. It allows the workers to save and invest a piece of their paycheck before the taxes are taken out. In this plan the taxes aren't paid until the money is withdrawn from the account. Most of the people choose to invest in some or other financial options to secure their family's financial future, pay off excess debt and provide for their loved ones long after their death. Annuity acts as a common investment tool to aid in these struggles.

Annuities are designed to help accumulate assets as an additional form of income. Annuities are a financial contract between the investor and an insurance company. In exchange for a large lump sum or periodic premium payments this long term investment provides ongoing income payments for a fixed period of time or until your death.

Comparing Types of Annuities

Annuities are of different types, differing by the payout options, benefits and how payments will start. Deferred, immediate, fixed and variable annuities are some of the common types of annuities.

Immediate Annuity:

An immediate annuity, which is otherwise called as a single premium income annuity, is a financial contract designed to provide steady income payments over a period of time.

This financial option is ideal for individuals close to retirement because payments are disbursed immediately or within a year of purchasing the contract. For example, if Ravi is nearing retirement within the next year or few months, he may choose to invest in an immediate annuity. Ravi will pay the lump sum value up front, and in exchange will begin receiving periodic payments for a set amount of years or until his death. Payments should begin contributing within the same year of the annuity transaction.

Unlike many annuity types, the immediate annuities do not require any promiscuous maintenance or management fees:

Prior to being disbursed, immediate annuity payments grow tax-deferred, allowing interest to accumulate over time. Annuity contracts include an accumulation stage, allowing annuity owners to gradually build up the cash value of their investment through periodic payments. An immediate annuity contract skips this stage because it is paid with a lump sum.

Deferred Annuity:

Unlike an immediate annuity, deferred annuities are not disbursed until later in life. This annuity type is a customizable investment, allowing annuitants to choose when their payments are disbursed and how they are received. In a similar example, Jane wants to invest in her retirement early. She chooses to invest in a deferred annuity, customizing her contract terms to disburse periodic income payments after 15 years. If Jane is 45 prior to purchasing a deferred annuity, her payments will begin disbursing when she reaches the age of 60.

Deferred annuities include an accumulation phase and an income phase. Within the accumulation stage, annuity premiums are paid through a one-time lump sum or a series of payments, allowing the invested assets to accrue interest over time. The income phase allows the annuity owners to choose how and when they receive their income payments.

Assets are disbursed once an annuitant reaches the age of 59 ½

Insurance companies allow investors to withdraw funds not exceeding 10 percent of the annuity account value. However, if an annuitant withdraws funds before the age of 59 ½, they may be subject to paying a 10 percent penalty to the IRS in addition to other income taxes.

Fixed Annuity:

A fixed annuity is a financial vehicle that will pay a guaranteed rate of interest. Though the interest and principal are guaranteed, early withdrawals will subject to high surrender charges, specifically if funds are withdrawn before the age of 59 ½.

Fixed annuity type contracts provide a number of payout frequency options in exchange for a lump sum or periodic premium payments. Some of the major payout options include:

Variable Annuity:

Unlike a fixed annuity, variable annuities are financial options that provide the opportunity to invest in subaccounts and generate a higher rate of return. They do not guarantee a fixed interest rate or consistent monetary amount. While a variable annuity guarantees an income stream, the amount will differ depending on the performance of subaccounts. For example, after investing in a variable annuity with a monthly payout of $6000, Ravi may receive an added $400 or more a month if the subaccounts perform well.

Monetary contributions still grow tax-deferred, and this contract guarantees a death benefit in the event an annuitant dies before all assets have been disbursed. No matter how the invested subaccounts perform, variable annuities will ensure beneficiaries receive no less than the initial investment amount.

Annuity Pros and Cons:

Yet all the annuity option offers a different sets of benefits, they share some of the major advantages and flaws. Some of the other benefits are

Consistent Income :

you will be guaranteed with a stream of income payments over a long-term period, only when you elect a periodic payment method. The contract to provide ongoing payments until the death versus fixed term can be customized by the annuitants in some cases.

Tax-Deferred Status :

Until the payments are disbursed the contributions to an annuity contract grow tax-deferred. This will allow the assets to accumulate interest, and may significantly add to the over time value of the investment.

Asset Protection :

No matter how assets are invested the annuity owners can always expect to receive payments equal to the initial value of their investment. This is true in the case of variable annuities. In this option if the accounts perform poorly the owners will have a loss in their investment at the same time they will have a higher rate of return if the accounts perform well.

Death Benefit :

If suppose the annuity owner dies before the end of their contract term or before all the assets have been dispensed they can decide to include a benefit in their contract. When you add a benefit it ensures that all remaining assets transfer to a spouse or legatee.

Some of the major cons of the annuities are:

Fees:

Many annuity investments charge annual fees for the maintenance and management. Other fees include commission, mortality and expense and administrative fees.

Inflexibility:

The insurance companies will not allow you to change your contract terms in order to receive a higher payout or a lump sum.

Surrender charges:

In the event of an annuity owner needs to withdraw from their annuity account before the disposal period, they will be subject to paying surrender charges. This is especially true in the case if an annuity owner has not reached the age of 59.5, at which they will be subject to paying a 10 percent penalty fee to the IRS.

Annuity Payouts

Flexible payout options are offered by annuity investments. At the time of settling the terms of an annuity contract, the owners can choose the frequency of payments, the amount disbursed and how the payments are received.

The lump sum payment option and periodic payments are the two most common payout options.

With the help of lump sum payment, the annuitants can convert their assets for a one-time cash payment. This option provokes a larger amount of taxes. The lump sum annuity interest will be levied as an ordinary income, and annuitants will be required to pay a larger sum of taxes all at once within the year of disbursement.

Interested in Selling Your Payments?

A periodic payment will guarantee a steady stream of income until an annuitant's death or over a set period of time. This payout option also allows the assets to accumulate more interest within the collection stage, providing more money over time. The owners may choose to transfer the payments to a spouse despite of providing income for life. Periodic payments are taxed with each and every withdrawal or disbursement.

How Do Annuities Work at Death?

When an annuitant dies even before the end of the annuity contract, the remaining assets will be surrendered to the insurance company that issued the annuity contract. This happens only when there is no death benefit in the annuity contract. This option will ensure the spouse or any other close relatives of the annuitant receive all the remaining payments until their death or till the end of the contract term. Also the death benefit statement requires the legatee to assume all the responsibilities and tax liabilities of the annuity contract.