Saturday, April 9, 2011

What Is An Annuity And How Does It Work

With just some years left for your retirement, you would definitely want to retire in the best possible way. And the most ideal retirement plan is one that guarantees a comfortable lifestyle with no financial concerns. With so many pension and retirement products available in the financial market, a person is bound to get confused to pick up the best one that guarantees maximum benefits. One such pension product is annuity. But most people do not have any knowledge about annuities, especially those who are new to the investment market. But with the recent market crash and subsequent losses, annuities are gaining popularity. Though complex, annuities do guarantee you sufficient returns. But before jumping into it, it is important for a person to know what an annuity exactly is and how does it work. It is a kind of investment wherein you make payments for a certain period of time, or pay one large amount of money. This, in turn, gives you a set amount of income at regular intervals for a particular period of time. Let’s find out more about the types of annuities and how do they work in the following lines.
 
Types of Annuity
A person who wishes to invest in an annuity has several product types to choose from. Depending upon the choice, the return on investment can vary. The different types of annuity are fixed, variable, hybrid, immediate, and deferred.
 
Fixed annuity offers a fixed rate of return on your money invested. It can either be a set amount or a set percentage of assets in the annuity. It pays out a guaranteed and predictable income amount, irrespective of what’s going in the financial markets. As such, fixed annuities pay a low rate of return since they are considered to be safe, compared to other kinds of annuity.
 
Variable annuity offers a variable rate of return on your money, though it pays higher returns. It has a minimum guaranteed amount but can increase depending upon how the kind of investments you have selected, such as stocks or mutual funds, perform from time to time. As such, you can expect to get higher returns with a better condition of the financial market and vice versa.
 
Hybrid annuity combines the features of both fixed and variable annuities. In such an annuity, you can withdraw certain amount of investment from your account while you can leave the remaining with hopes of growth with a variable rate of return.
 
Apart from the above three kinds of annuity, you have an option of choosing for an immediate annuity. It is a kind of investment that provides you with an immediate income, or at least within a year after you buy it. You pay a large lump sum amount, also known as single premium, and start receiving income from that money every month. Your monthly payment will depend on certain factors, like age, gender, and marital status. The older you are when you buy an immediate annuity, the higher will be the payout.
 
An investment, when made at a present date, gives you returns at a future date is called a deferred annuity. During the entire annuity’s “saving phase”, you make one or multiple contributions in terms of money and start receiving income as either periodic payments or lump sum with the beginning of the “distribution phase”. Similar to a retirement account, a deferred annuity allows you to deposit money and make use of it in the future.
 
How Does An Annuity Work
An annuity is a financial contract that is made between a financial institution and an annuitant. The financial institution that sells the annuity product is known as an insurance company, also called an issuer. The annuitant is a person who buys the product and hence, is known as the buyer. The buyer makes a lump sum payment or pays periodic amounts to the issuer on the context of receiving regular payments either immediately or after a certain period. The entire term of an annuity plan is divided into two phases: the accumulation phase and distribution phase.
 
In the accumulation phase, the buyer begins depositing money to the issuer, either in lump sum or regular fixed payments. The next comes the distribution phase wherein the issuer makes periodic payments to the buyer similar to the income payments made by him. An annuity plan is often accompanied by a life insurance component which requires the payment of a lump sum or periodic payments to the beneficiary, in case the buyer dies before he starts receiving any annuity payment or has received all the payments. The buyer will only start receiving the annuity payments on the completion of a certain age. In most of the cases, the buyer should complete 59½ years after which the periodic money can be withdrawn.
 
In case the buyer withdraws any amount before reaching the specified age, his amount will be levied with certain charges, such as tax penalties and surrender charges. The tax charges applied include 10 percent of the deposited or investment money plus regular tax payment rate on the interest returns. The issuer, or the insurance company, calculates the surrender charges on the withdrawal time and annuity plan.
 
To avoid any kind of inconveniences and circumstances, it is best to consult a financial professional to check out which annuity plan is the best for you.

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