How Do Annuities Work?

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How Do Annuities Work?
by: Robert Eldridge

Annuities are a form of insurance product which can be a smart investment to ensure your security when you retire.

Benefits of Getting an Annuity

An annuity lends itself well particularly in terms of funding retirement and even education, in some cases. It can be an effective investment plan for you if you want a guaranteed flow of income for a given period of time, even when you have stopped working. It can also work for you if you want to save money for a long term goal.
Before getting an annuity, you might want to assess its costs compared to other alternatives. In some cases, purchasing tax-deferred investments and life insurance separately can be more effective, cost-wise.

How annuities work

Essentially, an annuity provides for you when you will have stopped working. This is different from a traditional life insurance in which it covers you at the time of your death. Simply put, you purchase an annuity and in return, receive a series of payments periodically. These payments are guaranteed as to the period and amount.
Annuities for the purpose of funding education works in which the annuity is placed in the child's name. The child, under the stipulations of the Uniform Gifts to Minors Act, pays the tax on the earnings including a 10% penalty upon maturity. A downside of an annuity for funding is that the child can freely use the money for purposes outside of education.

There are different kinds of annuity investments to choose from. If you prefer to be paid for your annuity over your lifetime, you are guaranteed a stream of income even until your death. If you die before your life expectancy, the insurer will pay you the amount less than what you put in.
If you live longer than your life expectancy, however, you may be paid more than your annuity cost as well as the earnings. An annuity differs from other typical investments, of which you may run out of funds with the latter even before your death.

In an annuity, the resultant earnings are tax-deferred. This means that there is no tax on these earnings until paid out. Tax deferral in annuities allows your funds to grow faster as compared to traditional investments that are taxable in nature. While this can be an advantage, it may also be a drawback since you cannot use your money without being taxed or incurring penalties.

As imposed in the tax code, a penalty of 10% for premature withdrawal is taken out of an annuity before the age of 59. Insurers also impose ‘surrender charges' (penalties) for withdrawals done before the end of the term.

How Do Annuities Work?

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How Do Annuities Work?

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