Annuities are investment vehicles sold mostly by insurance companies. There are several different types of annuities in existence. There are two basic characteristics that distinguish different types of annuities from one another. One of them is whether the payout on the investment is up front or deferred. The other is whether returns are fixed or variable. An annuity promising immediate payout starts paying investors right away, while deferred payouts indicate that investors have to wait for some known later date to start receiving payouts.
Fixed return annuities are ones in which the rate of return is fixed or guaranteed. Government bonds and other low risk securities are examples of guaranteed or fixed annuities. They are great for investors who just want to put some money away and do not want to risk losing the principal. But in exchange for the lower risk, they typically payout lesser returns as well. Annuities with variable returns offer payouts that are tied to the performance of the funds in which they are invested. Variable annuities may pay out large amounts of money or none at all depending on the performance of the stock or other sub account they are tied to. It is therefore important to choose a financial advisor that is cognizant of the intricacies of this type of product.
With fixed annuities, the investor basically hands over a certain amount of money to an insurance company. In exchange, that insurance company agrees to pay back the investor at a certain rate per month for a certain period of time. Both the amount per month and the length of time are preset when the annuities are purchased. Payments can begin right away or at a selected date in the future. Some people choose single premium deferred annuities (SPDAs) that begin paying out when they retire. These vehicles give them a predictable source of cash to help them live on when they're done working. They can be used as tax deferred investments or as a way to convert a single lump sum of cash into a steady stream of installment payments. Folks who receive lump sum payments in civil liability lawsuits may choose to defer some or all of the monies to a later date and convert them into periodic payments to help them make the money last longer.
Fixed annuities have two varieties in terms of the length of time for which payments are made. One of them is a fixed period when the investor simply chooses a length of time for which the payments will last. The other is an annuitized payment. In this scenario, payments last for as long as the investor lives. The time period chosen is the length of the investor's life.
A variable annuity is an insurance contract combined with an investment vehicle. The insurance policy provides a tax deferral. The insurance contract and the investment vehicle come together to form a product with some distinctive features. Tax deferrals on earnings are a major plus on these investments, as is the ability for the investor to designate a beneficiary for the remaining balance upon death. Annuitizing payments is another feature. The insurance component of variable annuities includes some guarantees which make this a safer investment than some.
In terms of the question of whether investors should buy annuities, the answer has to be found in an examination of its costs versus the insurance coverage and benefits provided. In this way, annuities are no different than any other insurance product. In many cases, other investments are better. Most experts recommend maxing out IRA and 401k contributions before investing in an annuity. Some endorse avoiding annuities entirely.
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