Annuity

From ArticleWorld

An annuity is a legal contract or agreement offered by insurance companies or other organizations that regularly makes an usually fixed payment to individuals and couples over a specified period of time or over a lifetime in return for a investment. It is usually used as a form of retirement income. In United States annuity contracts are defined in Internal Revenue Code and carry tax benefits. In addition to the usual annuity contract as described above which is called an immediate annuity, there is also a newer deferred annuity contract created expressly to take advantage of tax benefits.

Immediate annuity

This type of annuity has been around for at least four hundred years and they are primarily insurance policies that provide a guaranteed retirement income by paying a fixed or increasing amount of money regularly. Some immediate annuities called period certain annuities are paid for a specified period only. Life annuities in contrast provide an income for the full lifetime of the annuitant. Some life annuities will go on paying to the surviving spouse of the annuitant in return for lower payment. Others called life with period certain have a minimum guaranteed period of payment so that heirs of annuitant will receive the annuity even if annuitant dies early. Yet others have payments that increase with inflation or by a fixed amounts at periodic intervals. Longevity annuities start paying at very late in the retirement of the annuitant in return for less investment. From insurance companies perspective annuities can be considered as loans received from annuitants with a period of repayment equal to the lifetime of the annuitant. Only the interest portion of the annuity is taxable the principle or original investment is not taxed. Insurance companies can guarantee to keep on paying annuities for the life time of annuitants because they can rely on the concept of cross-subsidy. In actual fact annuitants who die early subsidize the ones who live longer.

Deferred annuity

This newer form of annuity contract came in to being in 1970s. This is designed to take advantage of the fact that increase in accumulated investment in an annuity is not taxed until it is withdrawn. Individuals can accumulate savings in such an annuity with tax deferred until withdrawal. Annuity can be withdrawn as a lump sum or it can be converted in to an immediate annuity. Deferred annuities can be classified according to the type of assets the investment can be allocated to. Fixed deferred annuities grow through interest accumulation only. Variable annuities allow allocation of investment in stocks and bond funds and unlike fixed annuities they do not guarantee that the investment will stay above the initial amount. New kind of deferred annuity called equity indexed annuity guarantees the initial amount while also allowing for participation in any increase in a major stock index like S & P 500. Commissions on these and other guaranteed annuities can be quite high.