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What Is an Annuity?

IMSA Consumer Guide to Annuities

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 When the money is withdrawn, only the investment earnings are taxed, not the amount of money invested.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. 

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. 

Excellent videos for a better understanding of annuities:

AIG “Cut the Small Talk”  (FA & IA)
AIG “ Cut the Small Talk” (Index Annuities)
Lincoln Financial Group – FIA Basics
Lincoln Financial Group – LINC Edge
Lincoln Financial Group – Lincoln OptiBlend® Fixed Indexed Annuity

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