How Annuities Work The Basics


Written by Jayant Row in Investments
Viewed by 85 readers since 04-28-2009

Annuities are considered the ideal savings instruments for the present generation of investors. A significant amount of money can be saved, that can help reduce your tax liability, as well as ensure that you have a steady income throughout the period of the annuity.

You can buy an annuity from an insurance company with certain conditions. The payment can be made as a lump sum, or you contract to pay the insurer periodic payments over time. The money with the insurance company keeps growing, and this growth of income is added to the lump sum in the annuity.

The rate at which the annuity grows depends on the type of annuity you have signed up for. A fixed rate of growth is called a fixed annuity plan. There are other annuities, where you allow the insurer to invest your money in the stock market, and the growth can vary as per conditions in the stock market. This can even be negative at times. Such annuities are called variable rate annuities. Some annuities which are called equity indexed annuities have a minimum assured return.

The value of the deposit with the interest earned is returned to you at a certain date after the period of your annuity is over. This payment can be made to you in the form of fixed payments at certain intervals if you have opted for a Term Certain Fixed Annuity. You can also opt for fixed payment throughout your life in case you have signed up for a Fixed Life annuity. If you have a Fixed Immediate Annuity you will be paid the entire sum by the insurance company as soon as the period is over. You can defer this payment to a later date in a Fixed Deferred Annuity.

Before you decide to invest in an annuity, you need to make an assessment of your future requirements and plan your finances for the years to come. It is only then would you be able to judge the best annuity for you.

Earnings in an annuity do not attract any tax and are normally free from any limits to the amounts you can put in them. However withdrawals after a certain age are taxed as income, and if you make withdrawals earlier than the specified time you would pay a penalty of 10 percent in addition to any tax that the withdrawal may attract. You can change your investment options without attracting any tax, but insurance companies do levy transfer fees also known as surrender charges.

A policy that pays out a fixed sum annually after the investment phase is over is considered to be annuitized. You would pay tax only on the annual amounts received, while the total income in the annuity will still be tax free.

Variable annuities represent a big source of income for brokers, and hence the tendency by them is to market this product more aggressively. Capital gains in an annuity are not extinguished by the death of the policy holder, and his heir will have to pay taxes on these before he can claim the annuity. Variable annuities have the potential of higher gains but also the possibility of a loss. Fixed annuities will give you the same income immaterial of market conditions and are therefore considered safer.


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