An annuity is a contract with an insurance company to make periodic payments for retirement income and sometimes other purposes.
There are basically two types of annuities.
A fixed annuity earns a guaranteed interest rate over a specific period of time. When this period of time expires a new interest rate is set for the next period of time. Is important to note that a fixed annuity is not backed by the Federal Deposit Insurance Corporation (FDIC).
Variable annuities offer a much greater range of investment funding options than fixed annuities. Because their performance depends on the investment options your principal and return are not guaranteed. Some variable annuities offer a fixed accounts alternative that guarantees principal and interest a lot like fixed annuities. You can then divide your funds between the low-risk option as well as high-risk options such as stocks.
There are two ways to purchase annuities. You can either pay the premium using one lump sum or you can make ongoing contributions to what is called a flexible payment annuity. With a flexible payment annuity you can contribute money pretty much any time you want. Another benefit of variable annuities is that they allow you to transfer money from one account to the other without having to pay taxes on any earnings you make as a result of the transfer. The disadvantage of variable annuities is that you will most likely pay higher fees than you would with a fixed annuity.
If you are wanting to save money for retirement a fixed tax deferred annuity may be the best option for you. With a tax-deferred annuity you don’t pay taxes until you make a withdrawal or begin receiving annuity income. This can allow you to accumulate a greater amount of money over an extended period of time. You should think carefully though before putting money into a tax-deferred annuity. If the money is needed before age 59 and you withdrawal the money the IRS may apply heavy penalties. In addition the insurer may also impose its own withdrawal penalties which are often cause surrender fees.
You can also purchase what is called an immediate annuity. When you purchase an immediate annuity you make a one-time payment and distributions usually begin within 30 days. Immediate annuities can be fixed or variable. Because an immediate annuity can provide stable income payments guaranteed for a selected period of time, this is a good option if you need a financial vehicle that can provide guaranteed income for life.
Before purchasing an annuity is important to speak with a professional financial adviser so you have an understanding of the various tax consequences of an annuity as well as the expenses which may be associated with the contract.