Defining Annuity

The term annuity is defined as a contract that pledges to create recurring payments for a specified period of time. Some examples of the different types of annuities offered by insurance companies are Life Annuities and Twenty Year Annuities. Annuities are typically sold by insurance companies and can be either immediate or deferred.

A Brief Summary concerning Immediate and Deferred Annuities.

The following is a concise review of the differences between Immediate and Deferred Annuities. An Immediate Annuity is an annuity that generates a disbursement for the following month and can be arranged to generate a disbursement for additional approved dates. This type of an annuity requires a sizeable investment (i.e., a possible one-time investment could be $100,000). A Deferred Annuity, on the other hand, would begin at a specified upcoming date to coincide with a particular, prearranged event (i.e., for an elderly person looking for retirement) and provide more income to the annuitant. Investors in this particular type of annuity develop recurrent investments which will increase the considerable sum that is subsequent to the payment procedure. This would be the acceptable manner upon which to finance a specific future event (i.e., financing for children’s education). However, it is best to keep in mind that typically, annuities have most often been applied to retirement objectives.

A Concise Overview of Fixed versus Variable Annuities

We have just briefly discussed the primary differences between Immediate and Deferred Annuities and we will now focus on the main distinctions between Fixed and Variable Annuities. Fixed Annuities are annuities that will disburse an equal amount for each month. In contrast, Variable Annuities will disburse an amount that will rely upon the investment performance of the assets held by the specific annuity. Therefore, a Fixed Annuity can be compared to a defined benefit pension plan (i e., Social Security) whereas a Variable Annuity can be compared to a defined contribution pension plan (i.e., a 401k).

The Importance of Annuities and Tax Deferred Investing

The significance of annuities can be discovered in the benefit gained from Tax-Advantaged Investing. In other words, despite whether the annuity may be for a retirement objective, once the funds are invested then the growth of any capital, dividends and interest will all be tax deferred. Investments into annuities could be either tax deductible or non-tax deductible contributions and may rely on whether the annuity is within a retirement objective.

To give us a better understanding, let us study the circumstances surrounding a twenty five year period. In this particular scenario, growth of the capital invested has revealed surprising results. In regards to the tax treatment of payments from annuities, they are usually taxable. Nevertheless, the tax rate will rely on the source of the finances. Annuities yield distributions that are compensated for by tax deductible contributions that are completely taxable at the recipient’s current income tax rate. However, for non-tax deductible funds, annuities yield distributions that are treated as a special case circumstance due to the fact that several of the recurring payments are in fact a return of invested capital and therefore are not subject to being taxed. At the recipient’s current income tax rate, only the investment gain portion would be taxable. In addition, if the payments are less than the amount authorized by the IRS and the disbursements are given to a recipient that is either below the age of 59 ½ or is over the age of 70 ½, a number of penalty taxes may be payable. For more information regarding taxes, please read IRS Publication 575 by visiting www.irs.ustreas.gov.

Choosing the Best Option for Your Personal Needs

Making the choice between Fixed as opposed to Variable Annuities can often be confusing when attempting to decide which annuity is right for your particular financial circumstance. This significant decision that the buyer must make will be based upon whether the recipient requires a recurring disbursement that is fixed. The general rule for anyone that is below the age of sixty would be to decide on a variable annuity. In general, a fixed annuity should be preferred only if the buyer really requires the fixed income. A unique approach in dealing with fixed annuities is the utilization of investing the disbursements into mutual funds whereby the fixed annuity is paid for with non-tax deductible funds. This particular investment strategy will be the topic of a separate article.

DISCLAIMER: It is the conviction of the author that the information contained within this article was accurate and current at the time of publication. In the area of financial services it is important to note that there is always a constant state of change and any major amendments to pertinent laws may have already taken place. Furthermore, given that all annuities are state-specific offerings, availability of a particular product is based upon which state the buyer resides in. In addition, the products presented by various issuers may offer different investment choices. As a result, it is best that prospective investors consult their personal financial advisors to determine if whether or not there is a specific product that can suit their specific financial circumstances.