An annuity is an insurance contract by which money is paid in installments instead of in a lump sum, therefore, providing an income for a specified period of time or for the rest of your life.
The buyer of the annuity pays a lump sum to the insurance company that is called a premium and the insurance company, in turn, agrees to pay fixed installments to the buyer or the buyer's beneficiary.
There are two types of annuities. One is the immediate annuity and the other is the deferred annuity.
With the immediate annuity, the insurance company begins periodic payments to you soon after you pay the lump sum, usually within a year.
With a deferred annuity, the payments start after a longer period of time, usually after more than a year has passed or after you retire. With the deferred annuity, you may get some tax relief.
The tax on the interest credit of the deferred annuity is deferred from current taxation until you start receiving the payments.
Annuity payments are usually paid to you in monthly installments, but there are other options.
Option 1 is the Life Annuity: As long as you live, the insurance company will pay you an income.
Option 2 is the Period Certain Annuity: You will recieve an income for a specific amount of time that may be 5, 10, 15, 20 years, etc.
Option 3 is the Life Annuity with Period Certain: The insurance company pays you as income for life, but if you die before the period of payments you choose, the income will be paid to your beneficiary until the end of that period.
Option 4 is the Joint and Survivor Annuity: You will be paid an income during your lifetime, then after your death, a percentage of that income will be paid to your survivor during his or her lifetime.
There are also two types of deferred annuities. One is the fixed annuity and the other is the variable annuity.
The fixed annuity has a guarantee that your money will accumulate at a mimimum specified rate of interest.
The insurance company, however, will pay a higher rate of interest if it garners interest that is better than the minimum guarantee.
The variable annuity can be directed into several different accounts by the contract owner and their accumulated funds will reflect those accounts rather than those of the insurance company.
Variable annuities are riskier than fixed annuities, yet, there is the possibility of greater returns on the money invested.
A deferred annuity is not a good idea unless you are going to keep it for several years.