Annuity refers to a fixed payment made to a person regularly for any given period. It can also be seen as a kind of investment or insurance depending upon the nature of the amount and if it is seen as an income or expenditure. This may include payments to savings accounts, insurance, or pension payments.
It has a specific meaning concerning insurance. Insurance companies have several policies for annuities in which the customer is to make payments of a certain amount regularly to the company. In return, the insurance company pays back the customer a regular income (starting a stipulated amount of time later in the future). This may continue for the rest of one’s life.
Key Takeaways
- An annuity is a financial product that pays a fixed sum at regular intervals, for retirement income.
- Annuities can be immediate or deferred, with the former starting payments immediately after purchase and the latter starting at a future date.
- Annuities offer tax-deferred growth and guaranteed income for life but may also come with high fees and restrictions on accessing funds.
Types of Annuities
In practice, several kinds of annuities depend on the nature of the payment and the company disbursing the funds. Broadly it may be divided into the following categories:
- A fixed Annuity is a guaranteed fixed payment given to the customer by an insurance company in the future.
- Variable Annuity – This has lesser stability but may benefit the investor. This can happen if the mutual funds invested in by the buyer do well in the market and grow to a larger amount.
- Immediate Annuity – The payments in this system begin as soon as the customer invests with an insurance company.
- Deferred Annuity – This leads to an accumulation of money as the investor makes more payments, ultimately leading to a greater lump sum return in the future.
- Indexed Annuity – In this situation, the payments are linked to an index in which limits are set for minimum and maximum amounts for payment.
- Contingent Annuity – In this case, the annuity is paid only for meeting certain prerequisite conditions. A life annuity, for instance, will only be paid in a person’s lifetime. Till then, however, it is a certain annuity.
Advantages of Annuities
- It is a promising source of regular income in fixed intervals. The guaranteed steady flow of money makes it a highly lucrative investment.
- It is very advantageous as a retirement plan because of the cash flow.
- In joint life annuities for married couples, either one is liable to receive payments despite the death of their spouse (although a reduced amount). This benefits men and women who do not participate in the workforce and do not have a steady income.
Disadvantages of Annuities
- There is a surrender period in which the investor cannot encash the amount deposited without paying a hefty fee. This can go up to several years in some cases.
- Variable annuities risk losing the principal amount because of prevailing market conditions, whereas fixed annuities remove the scope for receiving higher payments.
- While the balance may increase steadily, any amounts disbursed by the company are subject to income tax.
- https://www.nber.org/papers/w7199
- https://www.cambridge.org/core/journals/astin-bulletin-journal-of-the-iaa/article/guaranteed-annuity-options/55E3DAC470DFFC10E62FCF2F2A415A50
Last Updated : 11 June, 2023
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
I’m not convinced about annuities yet, the article didn’t fully address the drawbacks.
I understand your perspective, but it does give a comprehensive view of the topic.
The disadvantages of annuities, especially the surrender period, seem like a huge drawback.
I understand the concern, but it’s important to weigh the pros and cons before making a decision.
Yes, it is quite a con to consider when looking into annuities.
I never realized how many different types of annuities there are. This was insightful.
Yes, it’s quite interesting. There’s certainly a lot to consider with annuities.
Agreed, the various types definitely provide different advantages and disadvantages.
The disadvantage of the surrender period is indeed something to think about when considering annuities.
For sure, it’s a crucial factor to consider when making investment decisions.
Informative article.
I think annuities are not as lucrative as they are hyped up to be, there are easier ways to plan your retirement and obtain regular income.
I disagree, there are certainly better investment options out there.
Actually, annuities can be quite beneficial if fully understood and utilized properly.
The article provides a good overview, annuities sure have their pros and cons.
Definitely, the article offers a well-rounded understanding of annuities.
I found the article to be quite useful. Annuities surely provide fixed intervals of regular income.
Absolutely, it’s a stable source of income for many, especially retirees.
Great article, I had a very informative time reading it. Annuities are a very promising retirement plan and investment.
Absolutely, the advantages and disadvantages are well explained.
I totally agree. This article covers all the aspects of annuities in great detail.
This article has made me see the potential of annuities as an investment.
It’s great that it was beneficial for you. Annuities are indeed a good investment option for many.