An annuity is a contract that you can purchase from an insurance company, which you can either pay for in one lump sum, or through a series of payments over a predetermined period of time. In return, you will receive payments after a specified date, or on a handful of select dates that are prearranged.
There are two distinctive payout options available to you, which include receiving payments for the remainder of your life or over a set number of years. Each option comes with their own pros and cons, the most obvious being the amount of money per payout. For a series of payments made during a set timeframe, for example, the payments would be equally divided over those pay periods whereas a payment plan set out over the remainder of your life would be lower, in order to ensure that the disbursements do not stop unexpectedly.
Other choices include the type of annuity that you choose, of which there are three – fixed, variable, and indexed.
- A fixed annuity is a guaranteed payment that is based on the balance of your account, with a modest return on investment that is comparable to a certificate of deposit.
- Indexed annuities are somewhere in the middle, concerning risk and the potential reward. You receive a guaranteed minimum payout, but the amount within an individual disbursement is tied to the performance of your investment portfolio.
Most annuities have provisions in them that limit, or prohibit, the withdrawal from the contract, and can include steep surrender charges over a predetermined period of time. After that time, restrictions are more lenient, but it is imperative to understand your particular annuity, so that you can maximize your returns. Annuity withdrawals made before age 59½ are subject to a 10 percent penalty fee, and any withdrawals may be subject to income taxes during the year in which the withdrawal was made.
*Annuity guarantees rely completely on the financial strength of the issuing insurance company. As insurance products, annuities may be subject to fees, certain charges and holding periods. Annuities are not FDIC insured.
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