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What Is an Annuity?
An annuity is a financial product sold by insurance companies that provides a guaranteed stream of income in exchange for a lump-sum payment or series of payments. It is primarily used for retirement income and offers tax-deferred growth until distributions are taken.
How Annuities Work
- You pay the insurer a lump sum or periodic payments.
- In return, you receive regular income payments starting immediately or at a future date.
- Payouts can last for a set period or for the rest of your life.
- Earnings grow tax-deferred until withdrawn.
Types of Annuities
Common types of annuities include:
- Fixed Annuity: Pays a guaranteed interest rate and fixed income.
- Variable Annuity: Invests in subaccounts; returns and income vary with market performance.
- Indexed Annuity: Returns linked to a market index with downside protection.
- Immediate Annuity: Begins income payments within a year of purchase.
- Deferred Annuity: Accumulates funds and begins payments later.
Benefits of Annuities
1. Guaranteed Lifetime Income
Provides income for life, protecting against longevity risk. Joint options available for couples.
2. Tax-Deferred Growth
Investment earnings grow tax-deferred, helping your money grow faster over time.
3. Protection from Market Risk
Fixed and indexed annuities offer downside protection, preserving principal during market downturns.
4. Customizable Features
Optional riders (for a fee) offer benefits such as:
- Long-term care
- Inflation adjustments
- Guaranteed minimum income
- Death benefits for beneficiaries
5. Predictable Retirement Planning
Provides steady income to supplement Social Security or pensions, acting as a personal pension.
6. Legacy Planning
Can be structured to leave income or benefits to heirs. Some offer return-of-premium guarantees.
Things to Consider
- Fees and commissions can be high, especially with variable annuities.
- Surrender charges apply if funds are withdrawn early.
- Less liquid than traditional investment accounts.
- 10% IRS penalty applies to withdrawals before age 59½.