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What Is An Annuity?


Several years ago, the sure-fire way to make money work was to invest in the stock market. Recent instability, though, has made such a move risky. If you have money to invest and you want to put it to work, you might want to consider an annuity. These funds are tools for saving and investing money, but they are rarely dependent on the financial rollercoaster that is the stock market. The facts below should leave annuities explained, and they should give you some idea of what sort of annuity might work best for you.

What Is An Annuity?

Simply put, an annuity is an investment. It functions somewhat differently than most, as it requires a rather substantial sum of money to fund and is only paid out over time. Consider it to be a “middle ground” between a certificate of deposit (large deposit, time-sensitive, accrues interest) and being the recipient of a large sum of money (single pay out, problematic for taxes, no change in sum). It allows its owner to avoid some of the tax consequences of receiving a large sum while still “putting the money to work”. An annuity is also an alternative to a traditional retirement savings account, as it can allow an individual or couple to fund an account to be paid out after a set period of time, usually over a period of time that is decided at the funding of the account.

How Do Annuities Work?

The typical annuity is funded by an insurance company. The party that wishes to hold the annuity will place a certain lump sum of money into a special account. Each year, the recipient will receive a certain amount of money from the lump sum, while the insurance company profits from investing the initial capital in a variety of stocks and bonds. While the money is “at work”, individual payments will be made to the individual that funded the account, and certain qualified withdrawals may also be made from the account. Over time, the initial sum will be fully distributed to the indicated recipient of the annuity, allowing the individual to avoid the tax consequences that might have occurred if the annuitized sum had been given as a lump sum.

Annuities are generally locked in to a certain period of time. As with many other similar accounts, there tend to be penalties for withdrawing the deposit before the end of the annuity term. Generally written in contractual language, an annuity might be best thought of as an agreement between the first party (the investor) to give the second party (the insurance company) a certain sum to invest, to be paid back over a period of years. It might be easiest, in fact, to consider most annuities to be an interest-free loan to the insurer or other annuity originator. A number of different annuities exist, though, and the variety of terms available can lead to a number of different pay-out schemes.

Different Types of Annuities

In general, annuities can be divided into those that pay out immediately, or those that have deferred payments. Immediate annuities are generally an investment tool, a way to avoid certain tax consequences for large payouts. These policies may pay out over a relatively short period, for periods that are determined by the life of the annuity holder, or for other set periods of time. A deferred annuity, on the other hand, tends to be a retirement tool. These funds are tax-deferred during the funding period, and may be paid in to ay once or over a period of time. These annuities can be thought of as a retirement savings account, as they may be funded until one is ready to make withdrawals.

Even past the differentiation of immediate and deferred policies, there are also fixed and variable annuities. These policies are exactly what one would imagine: fixed annuities have a guaranteed rate of return, while variable annuities are pinned to certain market fluctuations. Either one can be the “best annuity” depending on your personal needs, but one should remember that both types have significant drawbacks. A fixed annuity is only as strong as the annuity insurance company that backs it, while variable policies tend to have no guaranteed rate of growth or of return.

Finally, one must choose between liquid or non-liquid annuities. The liquid annuity has no penalty for withdrawals from the lump sum, and can allow the investor to have quick access to their cash (with certain tax penalties). Non-liquid policies, on the other hand, limit the amount the investor may take out of the fund to a certain percentage per year. Many of the non-liquid policies offer a bonus to the investor, perhaps as much as five or ten percent of the original lump sum. Which type works best for your needs will largely depend on your need for quick access to your money.

What Type of Annuity Is Best?

There is no easy answer to determine what kind of annuity that you actually need. Take the time to determine how soon you need access to the money, the purpose of the annuity itself, and the amount of risk you are willing to take. If you merely wish to save for retirement and do not trust the market, you might want to stick to a non-liquid, fixed and deferred annuity. Those looking to make money and have quick access might prefer a liquid, variable and immediate annuity. There are a range of options between the two, and different sorts of annuity may work for different individuals.

Annuities are a fine way to invest your money. They have less uncertainty than a 401(k), but allow for more flexibility and potential than a typical savings account. While the processes by which the accounts work may be a bit confusing, most individuals can determine what sort of program that they need by a simple consultation with a financial advisor. If you wish to put your money away safely for a rainy day, it might be wise to consider using an annuity.

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