What an annuity is and how it works?

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Author: Annutiy Zing

An annuity is an investment you make through an insurance company. It represents a contractual relationship between you and the company. And, although offered by only the insurance industry, annuities have little, if anything, in common with insurance coverage. Annuities are marketed and sold through insurance agencies, banks, savings & loan (S&L) institutions, brokerage firms, financial planners, and investment advisers.

When you purchase, or invest in, an annuity you are given certain assurances by the insurance company. These promises depend on the company issuing the contract (the investment) and the type of annuity chosen. There are three ways to categorize an annuity: (1) how the money is invested (fixed-rate or variable), (2) when income is desired (immediate or deferred), and (3) if additional monies can be added to the investment (flexible-premium or single-premium).

How the money is invested ------------------------- A fixed-rate annuity is very similar to a bank certificate of deposit (CD). The investor is assured of a guaranteed rate of return for a specified period of time. Usually, the longer the period of time, the greater the rate of interest. Just like a bank, an insurance company may offer a rate of return that is more or less competitive than its peers offer. Rates may be locked in for 1 to 10 years, depending on the annuity contract.

A variable annuity is similar to a mutual fund family. The investor selects from one or more different investment portfolios, called subaccounts. Portfolio choices may range from ultraconservative (a money market account) to quite aggressive (Pacific Basin Stocks). The investor decides how the money should be allocated and can make changes at any time.

When Income is Desired ---------------------- The investor (known as the contract owner), decides if and when income from an annuity is needed. An immediate annuity is for an individual or couple who wants to start receiving monthly, quarterly, semiannual, or annual tax-advantaged checks. A deferred annuity, which is the most popular type of annuity, is structured so that the investment grows and compounds, tax-deferred, indefinitely. At some point in the future, the contract owner may decide to start making withdrawals.

Adding Money to an Annuity -------------------------- If the annuity contract allows you to add money to your existing contract, the annuity is referred to as having a flexible premium. Virtually all variable annuities are flexible-premium. If the contract allows only a single, onetime investment, it is referred to as having a single premium. Almost all fixed rate annuities are single premium. Investors who want to add money would have to fill out a new application and accept the then-current interest rate(s). There is no disadvantage to having two or more single-premium annuities.