How Annuities Work
In many ways, annuities function much as Certificates of Deposit ("CDs") or savings accounts. An initial lump-sum deposit is made into a specialized investment account. Future periodic payments may also be required. The investor allows all funds to remain intact for a pre-specified period of time. Typically, the minimum time period is 5 years; however, it may be as long as 20 to 30 years. In financial parlance, this period of years is called the investment "term."Expiration of this term is known as "maturity." At maturity, previously invested funds may be withdrawn or reinvested at your option. Ideally, the investment will have increased substantially by maturity, due to interest earned on all deposits.
Unlike CDs and other liquid investment accounts, an annuity is also an insurance contract. In addition to investment returns, you receive life insurance covering during the annuity contract term. If you expire before the annuity term does, your heirs receive the face amount of the life insurance policy.
Annuity Advantages
Annuities' main advantage is tax deferral. Interest earned on invested funds is not taxed until withdrawal. Suppose you are in the 25 percent tax bracket and your average rate of return on a CD is 6 percent annually, you will net only 3.5 percent.
By contrast, Uncle Sam's hand cannot touch your 6 percent annual annuity returns. Unlike a CD, an annuity is not a liquid financial account.
When you finally settle down and claim your nest egg after a few decades, you may choose how to receive your well-deserved windfall. You may turn the tables and receive monthly income. Uncle Sam's tax bite is not nearly as bad with relatively small monthly disbursements as opposed to a single mega payoff.
You may even decide just to let all that loot sit there and do its thing all over again. Leave it alone and let it become a living legacy for your heirs. Uncle Sam will just have to be patient a little longer. The compounded interest remains tax-deferred.
What is better is that your bottom line will be much better for the wear after many years, due to annuities' historically high investment performance. The paltry returns banks offer on CDs cannot hold a candle to the bright outlook that paves your way to a comfortable retirement with annuity investment.
Something For Everyone
Annuities come in "fixed" and "variable" varieties. Fixed annuities provide a set rate of future income at a guaranteed minimum level. Variable annuities offer future income based upon market performance of specific annuity subaccounts such as mutual funds or stocks. Consult an investment advisor today to learn more about how annuities work.