Annuities – The Safest Conservative Investment
While most of us have heard of annuities and many of us have investigated annuities as an investment option, you may still have unanswered questions that this article can help to answer.
What is an annuity?
Simply put, an annuity is a type of retirement option obtained through an insurance company. In exchange for a lump sum investment or a series of initial contributions, the insurance company will provide a regular stream of income to the individual. These payments may have a specific duration or continue for the life of the individual; it depends upon the contract. The common feature of all annuity contracts is the option of the individual to receive life-long, regular payments from the insurance company. This is the feature that makes annuities an attractive addition to a retirement plan. The features of a specific annuity are determined by the annuity contract.
The basic features of an annuity contract
While annuities can vary greatly in their requirements and details, certain basic features are common to all annuities. These include:
- Payments made to the insurance company by the policy holder.
These payments may be a single lump sum, or a series of payments whose amount and duration are specified in the contract. The purpose of the payment is to provide the initial source of investment funds.
- A period during which funds are accumulated. This time period usually lasts for several years, except in the case of a single lump sum payment. During this accumulation period, the compounded growth of the fund is tax-free. Also during this period, withdrawal of funds by the annuity holder is extremely limited, and subject to hefty fees by the IRS and the insurance company. Any withdrawals by the holder before the age of 59 ½ are subject to a 10% penalty imposed by the IRS, as well as income taxes on the withdrawn funds.
- A distribution period which begins once the annuity holder reaches the age of 59 ½ or older. During the distribution period, the invested proceeds are returned to the annuity holder in regular payments. These payments are considered by the IRS to be regular income, not capital gains. The payments will continue to be made until the holder dies; at that time the annuity will pay out to the holder’s beneficiary or beneficiaries.
Because annuities come with features such as death benefits and life-expectancy estimates, they are considered insurance products and are offered by insurance companies. There are also several different types of annuities, which we will discuss in subsequent articles.