Although advertised as insurance, annuities are an investment product sold by life insurance companies, brokerage firms, mutual funds, banks and financial planners. It promises to pay a specific sum periodically for a specified number of years. For example, you could purchase an annuity that promises to pay you $2,000 a month for 30 years. Or you might be interested in buying an annuity for retirement income which will begin 15 years from now. The cost of annuities varies depending upon your age, sex, the number of lives that will be covered, the date that payments are to begin, and the method used to distribute the benefits.

Insurance companies offer annuities that can make annual or monthly payments which begin immediately, or at a specified date in the future. If you’re near retirement, an immediate annuity, which begins making monthly immediately, may be of interest to you. Purchasing this type of annuity requires that you pay the full cost of the annuity in a single up-front lump sum. For example, a $150,000 payment may purchase a $1,400 per month annuity for as long as you live. A larger up-front payment will purchase an annuity that pays a larger monthly income. An immediate annuity may be an attractive choice for someone who has accumulated a large reserve of funds that he or she would like to convert into a lifetime income.

Deferred annuities begin making payments on a specified date in the future. Let’s say that you want to receive monthly payments of $1,200 beginning in 25 years, when you expect to retire at age 65. A deferred annuity can be purchased by making either a large one-time up-front payment to the insurance company (say, $50,000, for example), or by making a series of much smaller monthly or annual payments. The insurance company, in turn, promises to provide you with monthly income payments of $1,200 for the rest of your life, beginning at age 65.

Variable annuities offer the advantages of investing in mutual funds (potentially high returns, diversification, protection from inflation, etc.) along with the added advantage of deferring taxes on investment income. Variable annuities make periodic payments that can vary in size depending on the performance of the assets in which the funds are invested. Typically, payments into a variable annuity are invested in common stocks or a combination of common stocks and bonds. The performance of those markets determines the return that’s earned by the annuity’s invested funds. The higher the return, the more rapidly the annuity’s pool of savings grows, and the greater the size of the payments that will eventually be received by the annuitant. However, variable annuities also have the possibility of reduced payments to the annuitant if the value of the investments that the annuity’s funds are in declines. Financial experts, therefore, advise that when considering the purchase of a variable annuity, you check the investment history over a period of ten to twenty years or more.

Annuities generally shield investment income from taxation until funds are paid out to the annuitant. Thus, annuities provide tax deferral rather than tax savings. However, early withdrawals are treated in the same manner as those of an IRA, which means that they could be subject to a ten percent penalty.

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