what is an annuity, and how does it work?

Answer 1

An annuity is made for a couple different reasons. One, it's there to protect from paying taxes on money until you use it at a later date. So say you had a 500k inheritence and needed to put it somewhere to grow until you used it later on. Then it may be good to put it into an annuity so you can not pay taxes on the gains in the meantime.

The second reason for an annuity is for guaranteed income for the rest of your life. So if you put money into it, it will grow until you decide to annuitize. The only bad thing is that you're paying extra fees and such to keep that money in there. And also, one much realize that once annuitized, the money is not able to be gotten to. You're only guaranteed that monthly payment and that's it. If you're looking for growth and income for your life, look for a good mix of mutual funds. They're your best bet, with a LOT less fees associated with them.

BUT.....one should never have an annuity within a retirement vehicle such as a 401k, IRA, 403b or anything of the sort. It's got high expenses and is not made for your retirement needs. Insurance agents often sell annuity IRA's and annuity 403b's because they are either not licensed to sell mutual funds, which should be utilized in a retirement account, or they're going after the MUCH higher commission they recieve on annuities.

Be VERY careful when looking at annuities.

Answer 2

There are a lot of misconceptions about annuities, and I see some of them in some of these other responses.

First off there are two basic types of deferred annuities (i.e. annuities where you are deferring an income stream) and they are variable annuities and fixed annuities. With variable annuities you invest your money in variable sub-accounts that act very much like mutual funds. VAs typically do have higher internal fees (Mortality Expense Fee and admin fee usually is around 1 -1.2% a yr in US), however they come with a lot of bells and whistles. Want to invest in the stock market to get a higher return but afraid the market may tank when you're 5 or 6 years away from retirement? A variable annuity can protect you from that with guaranteed income benefits (which IS a reason to consider them in a retirement account). There are all different types of VAs out there today, you can find low ME annuities and even no-load annuities. It is true, however, that a lot of people sell them because annuities, unlike mutual funds, do not qualify for breakpoint discounts, so agents do earn more money selling them than they would a similar amount in funds.

On the other hand, fixed annuities are typically principal guaranteed and have no fees. They pay a fixed rate of return that may change once a year or may stay fixed for a certain number of years. Want a conservative, low cost investment that is not tied to the stock market? Then a fixed annuity may make sense. Rates are pretty competitive with CDs, but are tax-deferred, meaning you keep more of your money for future income, and you control the taxation of your interest.

Immediate annuities take a lump sum of money and convert it into an income stream you can not outlive. You could elect a pay out like life with 20 year certain with cash refund, what that means is you'd get income for life, so if you live to 115, the annuity keeps paying, but, if you die within the first 20 years, your beneficiary can either continue receiving income payments until 20 years is up or, with cash refund, they can receive the portion of your original investment that is left. There are a lot of pay out options.

If you're looking at investing in an annuity, be careful of dealing with insurance agents. They can typically only sell their company's product, and it's always better than everyone elses. Go see a financial planner or full service broker, they will have more options available, demand to see multiple illustrations!

Answer 3

It is a form of life insurance. You pay money to an insurance company. Then you get your money back, plus interest, at a later date. Annuities are usually payable on retirement.

You can purchase an annuity with a lump sum payment or make periodic payments.

Immediate annuities are a separate type, where you don't have to wait to start collecting. For example, a person aged 62 can buy a $10,000 immediate annuity and immediately start getting $62 per month until he dies.

The current interest rate is about 4%. But it looks like you are getting 7.44% as a rate of return. It's because part of the payment is interest and part is your original purchase.

Answer 4

There are many kinds of annuities, but in UK the main one is that which people are compelled by law to purchase with their pension funds, when they retire. You pay your money and you get guaranteed payments, for the rest of your life, however long you live.

These payments consist of interest plus return of capital and so they are larger than you would get from any bank savings a/c and also pay less tax. So, you are better off, but when you die there is nothing to bequeath to your inheritors.

I think to be obliged by law to give our money to a financial company, without any control of their prices and profits, stinks. No wonder the salaries and annual bonuses they pay their senior staff from your money, are in the film star category. I would certainly never, ever, buy and annuity if I could possibly avoid it.

Answer 5

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