Devoted to understanding the basics and fundamentals of investing

What is an annuity?

An annuity is a contract between you and usually, an insurance company.  The contract specifies an exchange of your cash now for a stream of payments from the insurance company.  The payments can be fixed or variable.

There are three main variables in most annuity contracts.  These are when the stream of payments begins, whether you will receive a fixed or variable amount each specified period, and when and under what circumstances you can get principal back.

An immediate annuity begins the stream of payments to you immediately upon receipt of your investment.  A deferred annuity delays the stream of payments for some specified period or to some future date such as your retirement.

Fixed annuities pay you the same amount each period into the future.  In periods of high inflation, you may not have as much buying power as you thought you would.  This is similar to the coupon payment on a bond.  Variable annuities do not pay a fixed amount.  You are given the choice of many funds to invest in and what you get paid depends on how good your investment choices were.  Getting your money back is one of the great challenges or drawbacks of most annuity contracts.  Most contracts allow you to get the interest you have earned on the principal or up to 15% per year without being charged a penalty.  But be prepared for a penalty charge if you try to take more than the amount permitted in the contract.  If you withdraw before 59 1/2 years old, you may also be subject to tax penalties. 

You can buy an annuity contract that gives you liquidity whenever you need it, but it costs more for the same payment stream.

In my next post I'll discuss Viatical Settlements.