Annuities

An annuity is sometimes referred to as an "upside-down life insurance policy." With a life insurance policy, you normally pay a relatively small periodic amount in the present to get a large sum in the future. With an annuity, you normally pay a larger amount now in order to get periodic payments (starting immediately or at some point in the future) over an extended period of time. While a life insurance policy primarily protects your beneficiaries against the economic harm of premature death, an annuity is meant to protect you (and your dependents, or children, if you live long enough!) from the economic harm of outliving your life savings and other resources.

Annuities are available in various forms, including the following:

• A deferred annuity is one in which purchase payments are made in a lump sum (single premium) or installments, and annuity payments are to commence sometime in the future.
• An immediate annuity is one bought with a lump sum, with the annuity payments to commence immediately.
• A fixed annuity is one designed to assure the buyer of a lifetime (or other fixed period) of payments of a guaranteed fixed amount. The amount of these payments is based on the age of the annuitant (the person whose life the annuity is computed on) at the time the payments are to commence, the sex of the annuitant, and the rate of interest that the insurer will assume will be made from the purchase funds paid by the annuitant.
• A variable annuity (also known as a "market value account") is one in which the insurer invests the premiums (less investment charges) in a portfolio of securities. The value of the annuity provided varies with the performance of the portfolio. The purchaser of a variable annuity does so with the hope that the performance of the underlying securities will outstrip the return that would have been possible from a fixed annuity. Although there are never any guarantees, over the long haul, this looks like a sound bet.

Both the amounts that build up within the annuity (during the accumulation phase), and the amounts that are received as annuity payments (during the distribution phase), can qualify for favorable federal income tax treatment. Thus, purchasing an annuity can become a tax-deferred method of saving for retirement, especially for those business owners who don't wish to set up a retirement plan that covers all their employees.