What is an Annuity?
An annuity is a financial product, between you and an insurance company, that carries a money-back guarantee. In return for the premium you pay into it over time, the insurance company agrees to repay you the principal, plus interest, at regular intervals or in a lump-sum payment. Annuities come in a variety of options, carry guarantees against losses, and often are purchased as a way to provide long-term retirement income.
Types of Annuities
There are different types of annuities in the market today that vary in benefits, conditions, payouts and other factors. Here are some of the most common annuities:
Immediate (Single Premium)
The single premium annuity is purchased with a lump sum of money and guarantees income instantly. People approaching retirement are the largest segment of immediate annuity buyers.
A lottery annuity is a structured settlement that disburses payment to its owner over a period of years, rather than paying the winning recipient a lump sum of money.
Pensions pay the retiree a periodic, fixed amount based on salary and time of service with the employer before retirement.
A deferred annuity delays payments during the accumulation stage, where your asset grow tax-deferred; and distributes payments in the income phase as a lump-sum payout, periodic payments or through annuitization.
At one time, annuities were simple investment products that worked like old-fashioned corporate pension plans. The annuity paid out a regular amount of money to a retiree based on how much was put into the account over the years by its owner, an employer, or both, providing a guaranteed stream of income for a lifetime, regardless of amount invested.
Annuities were later tailored to individual investor needs and desires, offering variations of payment and liquidity options, survivor benefits, investment models, guarantees against loss, plus many other choices. Structured settlements and single-premium annuities are included in these categories.
A type of annuity often created as a result of a lawsuit where the defendant and plaintiff negotiate the future medical and family needs of an injured party. Once an agreement is reached, the defendant funds the structured settlement with periodic payments through a third party, usually a life insurance company. Some structured settlements allow for a partial lump-sum payment.
- Money awarded for a wrongful death claim.
- Winning the state lottery.
- Damages awarded from a workers' compensation case.
- Money awarded from a personal injury, lawsuit or insurance settlement.
Reasons for Structured Settlements
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Pros & Cons of Annuities
Annuities can be useful in the right circumstances. You should be aware of all their benefits, risks and drawbacks.
- Your money can grow tax-deferred.
- Safe investments generally backed by established insurance companies.
- Allows income for life, especially useful if you outlive your other available assets.
- Guaranteed against loss by taking risk out of your hands and transferring it to insurance company.
- Complex financial instruments with expensive fees, commissions and administrative charges.
- Your money is locked in for a certain period of time.
- Surrender charges and IRS penalties applied when withdrawing funds before age 59½.
- Relinquish the lump-sum payment option when you buy an immediate annuity or annuitize your deferred annuity contract.