An annuity is a contract, offered by an insurance company, that is designed to receive payments (lump sum or a series) from the purchaser of the annuity in exchange for a stream of periodic payments beginning at some point in the future.  The contributed cash amount into the annuity is held by the insurance company and grown over a period of time, before making payments to the policy holder.  Annuities are primarily utilized by those who are looking for a steady stream of cash flow during their retirement years.

Types of Annuities

Annuities exist in two forms; fixed and variable.  Fixed annuities are structured to guarantee the policy holder a minimum amount of interest during the accumulation years and also guarantees a fixed payment at the time of distribution.  A fixed annuity may be set up to make payments for a fixed period of time or an indefinite period of time; such as the rest of your life.

Variable annuities, on the other hand, do not guarantee the amount of your future cash flows.  Variable annuities allow you to invest your cash in a wide variety of mutual funds; thereby tying your future annuity payments to the performance of your investments over time.  Variable annuities are more suited for individuals with a higher risk profile. 

Payout Options

When purchasing the annuity, you will have to choose the type of payout that you prefer when distributions are made.  You can either select to receive an immediate annuity or a deferred annuity.  The immediate annuity will begin making payments to you shortly after you begin funding your annuity contract.  Typically, immediate annuities are funded with a large lump sum payment.  Conversely, a deferred annuity will start making payments at a later date and will usually be funded with a series of payments.  Deferred annuities will naturally have a larger monthly cash flow and are more suited for those who are seeking an extra form of cash flow at retirement.

If you are married and concerned about what will happen to your spouse after you may die; consider creating an annuity with a joint and survivor option.  This will guarantee payments to your spouse in the event of your death.  Since the insurance company is taking more risk, your monthly cash flow will be smaller than that of a single person annuity.
Annuity Basics
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Tim Ord
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