First question is, what is an annuity? An annuity is an amount of money that you receive on a regular basis.
It normally refers to an insurance or an investment. In either case you invest either a lump sum or make regular payments for a certain amount of time, and then receive an annual return on your investment.
There are two main types of annuities: deferred annuities and immediate annuities.
You pay money into an investment account or policy. The money is invested over a period of time. At a certain time, usually when you reach a certain age, you begin to receive regular returns.
This kind of annuity makes a lot of sense for people who want to put aside money for retirement.
You pay money into an investment account or policy, either as a lump sum or a fixed payment over a set period. In return, you receive regular returns right from the beginning.
This kind of annuity makes sense if you receive a large amount of money from a property sale, lottery ticket or inheritance, for example. You can place the (post tax) money into a tax deferred account, and get out what you need in regular annuities.
The main benefit that you get from investing your money in annuities is that your money will grow on a tax deferred basis. In that way annuities are similar to whole life insurance, except that you can benefit from the dividends while you are still alive.
You will still pay tax on any dividends earned from the annuity, but you won't pay tax on the money you pay in. There is no limit on how much you can contribute to your annuity. Other investment accounts, such as Individual Retirement Accounts (IRAs) and 401k accounts do have contribution limits.
Whether you opt for a deferred or immediate annuity, you should know what your options are. Insurance companies and banks offer different types of annuity accounts, but most fall into these categories:
If you like to know what you're getting, then this could work for you. A fixed annuity gives you a fixed amount of money that you agree on when you take on the annuity. You will receive this amount as stated for the full annuity period (most commonly until death).
For example, if you choose a fixed annuity that promises to pay out $10,000 annually from your 65th birthday until your death, you can count on receiving exactly $10,000 a year during that time.
If potentially growing your investment appeals to you more, then this may be a better choice. You will usually have a certain guaranteed payment, but if your money performs well you may receive much larger annuities. If the investments lose money, you will still receive the minimum payment. This will usually be less than the equivalent fixed annuity for the same amount of contributions.
The benefit of variable annuities is that your money could potentially grow.
If you want to keep one finger in each pie, consider an indexed annuity. This is similar to a variable annuity because it gives your money room to grow. But it's a lot more conservative than a variable annuity account because gains are fixed to a set of indexes.
Indexes are from Standard & Poor's, Dow, Nasdaq or others, depending on the policy. These indexes measure the performance of the market over a longer period (1 year or more). This protects your money from short term falls in the markets.
An indexed annuity provides a reasonably safe place to keep your money, but isn't a money-making vehicle like a variable annuity.
If you want to supplement your retirement fund or keep a large amount of money safe while you draw on it for your living costs, then an annuity may be the best way to do it.