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What Is an Annuity?

An annuity is a long-term, tax-deferred* insurance contract or investment designed for retirement. It allows you to create a fixed or variable stream of income during your retirement through a process called annuitization.

An investor can purchase an annuity with a lump sum or monthly payments. The money is invested for a future date, when the money can be taken by the investor either monthly, quarterly, annually or in a lump sum. That money can also be guaranteed for a specific period or for a lifetime.

If a person has an annuity with a guaranteed 10-year income, and that person dies after five years, the beneficiary will receive payments for the remaining five years.

If a person has an annuity with lifetime payments, beneficiaries receive nothing upon the death of the holder of the annuity. It is possible to get an annuity with lifetime payments and a set number of guaranteed years. In that case, if the person dies before the end of the guaranteed years, beneficiaries would receive the remaining guaranteed funds.

Money invested in an annuity can grow tax-deferred*. When the money is withdrawn, only the investment earnings are taxed, not the amount of money invested.

Similar to a 401(k) or other defined contribution plans, money from an annuity can be subject to an additional 10 percent tax penalty – on top of your current tax rate – if it is removed before 59 ½.

*Tax-Deferred: Tax-deferred means taxes on your interest earnings are postponed until a future point in time. By postponing taxes, your money compounds faster because you earn interest on dollars that would have otherwise been paid to the IRS. This enables you to accumulate more money over a shorter period of time, ultimately providing you with greater income.

There are three types of annuities:

FIXED ANNUITY: It provides a fixed rate of return based on the terms of your contract. Investors will receive a fixed income in retirement.

VARIABLE ANNUITY: It allows you to control how the money in the annuity is invested, such as mutual funds. But the payout amount will change with the performance of the investments. The U.S. Securities and Exchange Commission regulates variable annuities. GPAgency does not offer variable annuities.

INDEXED ANNUITY: It allows money to be invested in a stock market index, i.e. Standard & Poor’s 500. Payments are based on the performance. 

Why do people buy annuities?

People typically buy annuities to help manage their income in retirement. Annuities provide three things:

  • Periodic payments for a specific amount of time. This may be for the rest of your life, or the life of your spouse or another person.
  • Death benefits. If you die before you start receiving payments, the person you name as your beneficiary receives a specific payment.
  • Tax-deferred growth. You pay no taxes on the income and investment gains from your annuity until you withdraw the money.

Investor.gov/ U.S. Securities and Exchange Commission

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