An annuity is a financial product designed to provide a steady stream of income to an individual, or annuitant. Annuities are most often used as a method for providing income during retirement, once a person is no longer earning wages or salary.
The annuitant will typically contribute a certain amount of funds toward the annuity, whereby the insurance company promises to grow those funds to eventually pay out a stream of systematic payments that continue for a guaranteed amount of time.
These financial products can be structured in various ways depending on the needs of the annuitant. Financial institutions have created several types of annuities to supplement the annuitant’s income needs.
A Fixed Annuity is a contract designed to make fixed dollar payments to the annuitant for a certain amount of time, or until the end of the annuitant’s life. These contracts guarantee both the pay back of earnings and the principal payments contributed to the annuity.
A Variable Annuity provides a guaranteed minimum payment, and the remaining income depends on the performance of a separately managed investment portfolio. The portfolio typically invests part of the principal into equities, such as individual stocks or mutual funds, and the performance of the investment determines the total amount paid to the annuitant.
Annuities can be structured to defer payments until the annuitant elects to receive them. This is called a deferred annuity and is often set up for those who want to invest money during income earning years to eventually receive as income during retirement.
There are two phases to a deferred annuity, the investment phase and the income phase. An Immediate Annuity, however, is purchased with one lump payment and income begins immediately after the contract is purchased.
Annuities can be ‘qualified’ or ‘non-qualified’. A qualified annuity is funded with pre-tax dollars and the contributions are eligible for tax deduction. The earnings are not taxed as income until received by the annuitant; whereas, a non-qualified annuity is funded with after-tax dollars and distributions are not subject to income tax since the funds have already been taxed. Qualified annuities are often set up by employers who want to provide a retirement plan for their employees.
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