Annuities FAQs

An annuity is a contract between you (the purchaser or owner) and an insurance company. In its simplest form, you pay money to an annuity issuer, and the issuer then pays an income stream back to you or to a named beneficiary. Annuities are generally used to provide  income in retirement.

In an annuity, your money is tax deferred until you withdraw it. The tradeoff is that if you take your money out before  age 59½, you'll usually have to pay a 10 percent early withdrawal penalty to the IRS, unless an exception applies.

Most life insurance companies sell annuities. You pay the insurance company a sum of money, either all at once or incrementally. The type of annuity you own determines whether your money earns a fixed amount or an amount that depends on the equities in which the annuity is invested. At a designated time chosen by you, the  insurance company generally begins to send you regular distributions  from the annuity's account. Or, you may be able to withdraw the money  over time or in one lump sum.

Deferral of taxes is a big benefit, and so is the ability to put large sums of money into an annuity — more than is  allowed annually in a 401(k) plan or an IRA —  all at once or over a period of time. Annuities offer flexible payout options that can help retirees meet their cash-flow needs. They also offer a death benefit; generally, if the contract owner or annuitant dies before the annuitization stage, the beneficiary will receive a death benefit at  least equal to the net premiums paid. Annuities can help an estate avoid  probate; beneficiaries receive the annuity proceeds without time delays  and probate expenses. One of the most appealing benefits of an annuity  is the option for a guaranteed lifetime income stream.

When you purchase an annuity contract, your annuity assets will accumulate tax deferred until you start taking  withdrawals in retirement.

Distributions of earnings are taxed as  ordinary income. Withdrawals taken prior to age 59½ may be subject to a  10% federal income tax penalty.

Fixed annuities pay a fixed rate of return that can start right away (with an immediate fixed annuity) or can be  postponed to a future date (with a deferred fixed annuity). Although the rate on a fixed annuity may be adjusted, it will never fall below a  guaranteed minimum rate specified in the annuity contract. This guaranteed rate acts as a "floor" to help protect owners from periods of low interest rates. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company.

 An annuity is a distinctive financial product. Although it's not an insurance policy per se, it is a contract with an insurance company. Many different types of annuities exist, with many different features. A deferred annuity is a savings vehicle that accumulates  earnings on a tax-deferred basis. An immediate annuity is a financial  instrument that converts a lump-sum premium into a stream of payments  over a certain period of time or for as long as the annuitant lives.

Here's how a deferred annuity works: You (the  annuity owner) make a lump-sum payment or a series of premium payments  to an annuity issuer (the insurance company), which will accumulate  earnings at a fixed interest rate (a fixed annuity) or a variable rate  determined by the growth (or losses) in investment options known as  subaccounts (a variable annuity). This is known as the accumulation  period. With some deferred annuities, during the accumulation period you  are allowed to withdraw a percentage of the principal and earnings  without incurring surrender charges. Any earnings in the annuity are not  subject to taxation until distributed. At the end of the accumulation  period, you can receive the principal and any earnings in one lump sum  when the contract is surrendered (i.e., cashed in), or you typically can  exchange the deferred annuity for an immediate annuity. If you die  before surrendering the deferred annuity, your beneficiary generally  receives the principal and any accumulated earnings (although some  exceptions may apply).

An annuity may have certain guaranteed or  insurance-like characteristics. For example, a deferred variable annuity may guarantee that your beneficiary will  receive at least the amount of your original principal if you die, even  if the value of the annuity has declined due to poor performance of the  subaccounts you selected. And whether you purchase a fixed or variable immediate annuity, you're guaranteed to receive payments for life if you  elected that payout option, no matter how long you live. Deferred annuities are most commonly used to help save for retirement. 

There are many different kinds of annuities. Four of the most common are the following:

• Single premium immediate annuity: You pay the insurance  company a lump sum now and begin to receive withdrawal distributions for  a period of time you specify. The amount you receive will vary  according to the length of time the payments are to last and whether  anyone will receive the remaining balance at your death.
• Single premium deferred annuity: You pay the insurance  company a lump sum now and defer receiving withdrawals until later. The  amount of those distributions will depend on the value of your account  at the time your payments begin, the length of time the payments are to  last, and whether anyone will receive the remaining balance at your  death.
• Variable annuity: This type of contract is a vehicle for equity investments. You can do a one-time deposit or contribute throughout the life of the contract. You have choices as to how your money is invested in an offering of investment portfolios, and you may  invest conservatively or aggressively. The growth of your account value will vary, depending on your choice of investments.

A deferred fixed annuity is an insurance-based contract that can be funded either with a lump sum or through regular payments over time. Fixed annuity contracts are issued with guaranteed minimum interest rates.

Although the rate may be adjusted, it should  never fall below a guaranteed minimum rate specified in the contract.  This guaranteed rate acts as a "floor" to potentially protect a contract owner from periods of low interest rates.

The funds in your fixed annuity are able to  build and earn interest during the accumulation phase. You don't have to  pay taxes on interest earned until it is withdrawn. By postponing  taxes while your funds accumulate, you keep more of your money working and growing for you instead of paying current taxes. This means an annuity may help you accumulate more over the long term than a taxable  investment. Earnings that are withdrawn are  taxed as ordinary income. Fixed annuities provide an option for an income stream that could last a  lifetime. The guarantees of fixed annuity contracts are contingent on  the financial strength and claims-paying ability of the issuing  insurance company.

Equity-indexed Annuities have their value attached to indexes such as the Standard & Poor's 500 Composite Index.

Typically, an equity-indexed annuity will  guarantee a minimum rate of return, around 3 percent. Any additional  investment credits are tied to how well the market has performed. Even in a down year for the market, the policy will still have some  investment income.