Understanding Annuity Basics

An annuity can help your retirement money grow tax-deferred.

An annuity is a unique retirement planning alternative that can be tailored to suit the needs and objectives of almost anyone. Whether you prefer current income or a long-term accumulation alternative, check out annuities. They may be just what you need.

The basics of the annuity product

An annuity is a contract between you and an insurance company. In exchange for a current premium, your insurer agrees to pay you a future stream of income. Annuities are very flexible financial vehicles. You can pay your premium all at once or you can pay it over time - it’s up to you. In addition, you can specify when you would like to begin receiving the income from your annuity. You can start immediately or you can let your annuity accumulate. One of the most attractive features of annuities is that they are allowed to grow tax deferred. Because you do not have to pay taxes on the growth of your annuity until withdrawal, annuities have become an attractive accumulation alternative.

Two basic annuity types

Immediate Annuities

With an immediate annuity, payments usually begin a month after you have paid a lump sum premium. This makes them a popular source of supplementary income for retirees.

Immediate annuities provide some tax deferral. Only the interest portion of each payment is considered taxable income. The rest of each payment is considered a return of your principal. Taxes on the earnings of the annuity are spread over the payout period, which means you pay fewer taxes in the early years.

Deferred Annuities

With a deferred annuity, you allow your premiums to accumulate before you begin the payout period. Deferred annuities give you the option of paying fixed or flexible premiums, and you can pay them all at once or over time. The earnings of the annuity are not taxed until they are withdrawn. This may allow you to accumulate more over the long term than taxable investments would. And you decide when to start receiving income from your annuity.

Annuities are insurance-based financial vehicles designed to provide income in retirement. There may be a 10 percent penalty on amounts withdrawn prior to age 59½, in addition to regular income taxes. Surrender charges may also apply in the early years of the policy.