Some of the questions that people commonly ask about annuities include:
What is the definition of an annuity?
An annuity is defined as a contract between an insurance company and an individual, more often than not, for the purpose of retirement income. The investor, who in this scenario, is defined as the annuitant, contributes the money either in the form of a lump sum or in a series of periodic payments.
What are the types of annuities?
There is almost a seemingly endless variety of annuities. However, the most well known are fixed, variable, and combination. Other types of annuities include the charitable gift annuity and equity-indexed annuity.
The fixed annuity option guarantees a minimum rate of return. However, when the annuitant decides to receive income, the payout is determined by two critical factors such as the account's value as well as the annuitant's life expectancy based on mortality statistics. It is also important to note that the fixed annuity is subject to the risk of inflation and the cost of living but that the fixed payment option remains a permanent feature throughout the annuitant’s life span.
A variable annuity which involves more risk because it is invested in the stock market may have a better chance of keeping up with inflation than a fixed-income annuity (at least that is the hope!). Any money invested in equities always has the potential of risk. However, the payout from the variable annuity will vary because the value of the account will fluctuate with the stock market's overall value. Furthermore, the financial contribution an investor makes to the variable annuity account is held in an account that is separate from the account of the insurance company’s general funds. Special Note: it is the investor who bears the investment risk and not the insurance company. Every variable annuity must be registered under the Investment Company Act of 1940. Salespersons of variable annuities must be registered with the SEC and NASD as well as be licensed by state departments of insurance.
A combination annuity has the features of both a fixed and variable annuity. Often referred to as a “hybrid annuity, the combination annuity offers a certain degree of versatility in payment options. The investor makes financial contributions to the fixed account and the variable account.
What about sales charges on annuities?
The sales charge cannot exceed 8.5% of the total payments.
What types of other fees or charges are associated with annuities?
Annuities can incur a variety of fees such as an annual expense fee, contingent deferred sales charge, surrender charge, commission, as well as an administration fee.
What are the payment options?
Although there are many payment options, the most common are straight life, life annuity with period certain and joint life with last survivor.
Straight life: This type of annuity provides a periodic payment for the lifetime of the annuitant.
Life annuity with period certain: An annuitant receives payment for his or her lifetime with a minimum number of payments guaranteed for a specified period of time such as 10 years or 15 years, for example.
Joint life with last survivor: This annuity guarantees a payment for the entire lifetime of one or more individuals. Upon death of one of the beneficiaries, payments will still be made to the surviving beneficiary.
How are annuities taxed?
As annuities are tax-deferred investments, the interest, dividends, and capital gains cannot be taxed until the annuitant withdraws the money. The money that exceeds the cost basis of the investment is taxed as ordinary income.
Clearly, annuities are complex investment vehicles, and require specialized knowledge of actuarial science, taxation, and investment management. This is only brief exploration of the most basic aspects of investing in annuities. Hopefully, it will encourage people to explore this topic further by reading more articles and books.
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