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What is an annuity?

Annuity is a term which is most common among the business people but it may be not clear to all other people. It is a financial product which is sold by financial institutions that is designed to accept and also grow funds from an individual. Then pay out a stream of payments to that individual upon annuitization at a later point in time. Primarily annuity is used as a means of securing steady cash flow for the individuals at the time of their retirement years.

Now according to a wide array of factors and the details annuities can also be structured, like the time duration that payments from an annuity to continue can be guaranteed. It can be so created that, upon annuitization payments will be continued as long as either the annuitant or their spouse is lived. Again otherwise, annuities can structure for a fixed amount of time to pay out the funds, as such 20 years, or simply regardless of how much time the annuitant lives.

It can again be structured to provide a fixed periodic payments or variable payments to an annuitant. The variable intent annuities are to allow the annuitant to receive a greater payment if their investments of the respective annuity fund do well and smaller payments if their investments do poorly. This provides for cash flow of less stability than a fixed annuity, but it allows an annuitant to reap the benefits of a strong return from their investments of the fund.

There are different ways by which annuities can be structured, provide an individual seeking annuities, flexibility to construct the annuity contract which will best fit their needs.

The very term “annuity,” used in the financial theory, is now most closely related to immediate annuity which people call it in present days. This is simply an insurance policy by which in exchange for sum of moneys, comes with guarantees that the issuer will be given a series of payments. These payments could be either level or increasing payments periodically for fixed term of years. It is possible also to structure payments under an immediate annuity by which they vary with performance of the specified set of investments, usually equity mutual funds and bonds. This contract is called variable immediate annuity.

The characteristic of an immediate annuity is like it is some kind of a vehicle to distribute the savings along with tax-deferred growth factor. A very common use for the immediate annuity may be to provide pension income in a retire life. In the U.S., tax treatment of any non-qualified immediate annuity is such as every payment is combination of the return of principal (that is the part which is not taxed) and the income (i.e. taxed as ordinary income rates, rather capital gain rates). The Immediate annuities funded like an IRA don’t have any such kind of tax advantages, but the distribution satisfies the requirement of IRS RMD and might satisfy RMD requirement also for other IRA accounts of owner.

When deferred annuity is annuitized, it works such as an immediate annuity, but with lower cost basis from that point on and so more tax of the payment.

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