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What is Annuity ?
An annuity can be defined as an
agreement or contract between one person and an insurance
organization to pay a series of payments for guaranteed interest
bearing policy with guaranteed income options.
Investing in an annuity does not have any limits. Whether on investing in a deferred annuity or an immediate annuity
depends on the following:
• Current savings or investment portfolio.
• Long term financial goals
• Immediate potential and actual financial needs.
• Range of alternatives available.
If one is buying deferred annuity and is suddenly in need of
cash he/she can withdraw small amount without paying any
penalty. However penalty must be paid if the amount is withdrawn
in large amounts within few years after annuity is bought. In
immediate annuity amount more than the regular payments cannot
be withdrawn even if the cash required is emergency.
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Types of
annuity
Annuity can be classified based on the following:
• Based on the nature of investment it can be differentiated as
fixed and variable annuities.
• Depending on the purpose we have deferred and immediate
annuities.
• Depending on the status of tax it is divided into qualified
and nonqualified annuities.
• Based on the nature of one’s committed payment it is
classified as fixed amount, fixed period and lifetime annuities.
• Based on the arrangement made for paying the premium it is
characterized as single premium and flexible premium annuities.
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Fixed or
variable annuities
Fixed annuities are regulated by state insurance departments. In
this type, the money, which is there in the fixed annuity, will
grow and the value will not drop. In another sense the insurance
company will guarantee the rate of interest and the principal
amount. Some fixed annuities may credit higher rate of interest
depending on the performance of the investment of the insurance
company or through a policy dividend declared by the company’s
board of directors. There are two types of fixed annuity, which
include equity-indexed annuity, and market value adjusted
annuity. Equity-indexed annuity is similar to fixed annuity but
its value is also based on the specified stock index. Market
value adjusted annuity combines two characteristics one is the
choice to select and fix the interest rate and time period over
which the annuity will grow. The second is the adaptability to
withdraw money from the annuity before the time period is
selected.
Variable annuities are also regulated by state insurance
departments as well as the federal Securities and Exchange
Commission. In variable annuity the money is invested in a fund.
The fund may be a mutual fund and here there is only one open to
investors. The investors can invest in the company’s variable
life insurance and annuities. The money is paid depending on the
investment performance of that particular fund.
Deferred or immediate annuities
In deferred annuity as the name indicates the payment is made at
a later stage after receiving premiums and investment changes.
For retirement it can be delayed for decades.
In immediate annuity the payment is made immediately one time
period after the annuity is bought and depends on how often the
payment is paid.
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Qualified or nonqualified annuities
Qualified annuity is the one purchased from a tax favored
retirement plan such as plans governed by Internal Revenue Code
sections. In this type of plan the money, which is paid to the
annuity, is not included in the taxable income for the year in
which the money is paid to the annuity. In non qualified is the
one used to invest and disburse the money separately from
tax-favored retirement plan i.e. outside of retirement plan.
Fixed period and lifetime annuities
In fixed period annuity the payment is made for a specified time
period. Here the amount paid depends on the length of the payout
period and the interest rate at which the insurance company pays
for that particular length of payout period. In lifetime annuity
as the name suggests the income is provided by the insurance
company for the rest of the life of the annuitant. The amount
paid by the company depends on the interest rate provided by the
company and the age of the annuitant. In this we have something
called as “pure” lifetime annuity wherein the payment made by
the company stops once the annuitant expires even if he is
started within a short. |
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Single
premium and flexible premium annuities
A single premium annuity is the one in which the fund is given in
one single payment. The funded amount can be invested for further
growth.
A flexible premium annuity is the one in which the payment is given
in a series of payments. The growth here is expected before the
money is withdrawn.
Various attractive features of annuity
• If a person is receiving amount from an insurance firm i.e. if he
owns an immediate annuity then that money belongs to the tax-favoured
retirement plan and is protected.
•The annuity companies are giving various investment options like if
a person is investing the amount in fixed annuity he will be paid an
interest rate like bank certificate deposit. If he is purchasing a
variable annuity then the amount can be invested in mutual funds.
The annuity companies are given various options like they offer a
feature, which guarantees that the annuitant investment will not
fall below a certain value made by the most recent policy
anniversary.
• The investment earnings, capital gains and the investment income
in annuities are not taxable for an annuitant until he/she withdraws
the amount.
• If a person is made a lifetime immediate annuity then the
investment made is converted into series of payments called as
“pockets”. Generally it is given in three pockets: one is from the
annuitant investment, the other from investment earnings and the
last from the people in the annuitants group.
Difference between life insurance and
annuity
•Life insurance is bought in the event of dieing soon whereas
annuity is bought in the event of living too long.
• Annuities are of two types: deferred and immediate whereas life
insurance is divided into term and whole life.
• The main reason for buying life insurance is to provide income for
dependants and annuity is bought to accumulate the money in
tax-deferred product or to assure that one do not outlive the
income. Social security in an immediate annuity pays the retirement
income for as long as you live.
•Life insurance pays the income when the person dies and annuity is
paid when one withdraws or one period after you buy the annuity, it
stops paying when you die.
• Age during which life insurance is bought is between 25-30 in term
life and 30-60 in whole life whereas in deferred annuity it is 40-65
and in immediate annuity it is 55-80.
• Money accumulated in term life insurance is not tax-deferred.
Whole life insurance accumulates money as tax-deferred whereas both
deferred as well as immediate annuities accumulate money as
tax-deferred.
• The benefits received from life insurance are not taxable when
received whereas when received from an annuity it is taxable.
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Article Contributed By: Shilpa V
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