Annuity Definition wants to go over a basic understanding of annuities. Regardless of your age; it is essential to chalk out a retirement plan; after working for several years, when you eventually do retire, you should have a sense of financial security so that you can enjoy the golden years of your life. However, if you want to build a comfortable nest egg, it is crucial to diligently draw up an appropriate investment plan. There are several investment vehicles that can yield income in the future; however, after living through the current economic scenario, most people are looking for a risk free avenue to invest their hard earned money and one such investment vehicle is available in the form of annuities. Here is some vital information on understanding annuities and how they work

Understanding Annuities

An annuity is an insurance policy that covers your retirement income; it is a contract between you, the annuitant and a life insurance company; however, unlike life coverage, your family will not get anything in the event of your untimely demise. An annuity helps you to accumulate your money for future needs. When understanding annuities, it is imperative to remember that this investment option is not like a savings account or even a savings certificate and should only be used if you intend to cover your long term income needs.

How annuities work? The Premiums

There are two ways to invest in an annuity; you can choose a single premium payment plan or a multiple premium contract. As the names suggest, in a single premium contract you will have to pay the entire premium amount at one go and additional funds cannot be added to the annuity in future. With a multiple premium contract, you will get the liberty to make small periodic payment; these may be monthly, bimonthly or quarterly.

Multiple premium contracts are further divided into two categories: scheduled and flexible. If you choose the flexible contract, you choose the amount of money and the frequency of payment as long as these factors are within a certain limit; however, if you go for a scheduled contract, the premium amount and the frequency of payment are set through the contract.

How annuities work: Benefit Payments

When understanding annuities, you also need to find out when the benefits are paid; based on this factor, annuities can be divided into two categories: deferred and immediate.

Immediate: This type of contract is usually feasible when you choose a single premium plan because the income starts as soon as you make the payment. This option is suitable for people who have unexpectedly received a large sum of money and would like to turn into a secure, life long income stream. You also have the option to choose between a fixed and variable contract. In the former, a fixed benefit amount will be paid out every month or periodically while in the latter, the amount can be changed to meet your requirements.

Deferred: This type of contract is used to accumulate money through out your working years so that you can create a significant income stream for your retirement. The contributions that you make towards the annuity are tax sheltered and you are only taxed when you withdraw the income. The tax benefits coupled with the compounding interest can give you a comfortable income after you retire from work life.

Understanding Annuities:How does our premium earn you money?

When you buy the annuity contract, you will be expected to choose between fixed or variable contract; these terms will determine the way in which the money is credited to the contract

Fixed Annuity: Under this plan, a fixed amount of money will be credited to the contract; these payments are backed by a minimum interest guarantee and although your earnings may fluctuate, they will never go below the minimum interest rate. The rate is spelled out in the contract by the insurance company; once the pay out period is reached; a fixed interest rate is applied to the remaining amount.

Indexed contract: This is a type of fixed annuity contract; however, in this case your returns are determined by the performance of equity market indexes such as S & P 500 Composite Stock Price Index or the Dow Jones Industrial Average or even NASDAQ. The principle is protected against marketing movements, so you will never lose the capital while the gains will add to your income.

Variable Annuity: In this type of contract; you will be offered several investment options and you as the annuitant chooses how and where the insurance company invests your premiums based on your financial objectives and your appetite for risk. You can elect to invest your money in stocks, bonds or other investment vehicles; however, there are no guarantees in this case. During your pay out, you can choose to receive a fixed or variable income under the contract.

Understanding Annuities: The most important thing to remember when buying annuities

Make sure that you read the contract carefully; if you do not understand a clause, get the insurance agent or a representative of the company to explain it to you. Depending on the type of annuity contract that you choose, the value of your investment may increase or decrease so it is imperative to ensure that you have chosen the correct type of annuity for your needs.

Understanding Annuities: The benefits of putting your money in this investment vehicle

Limited Risk: Although the returns on annuity investments are lower than some of the other options; annuities are very safe.

Tax relief: You get tax shelter during the accumulating period and you are only taxed when you actually start receiving the income generated through annuity investments

No limit: Unlike 401k’s, there is no limit on the amount of money that you can invest annually in your annuity contract. So, you can choose to save as much as you want.

Flexible: You get numerous options to choose from when investing in annuities; the investment vehicle offers solutions for people with all sorts of financial goals and levels of risk tolerance. The annuitant can also decide on the way in which payments are received.

Alan DeLoy