Annuities and your retirement

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The term annuity is derived from the Latin word for year – annus. An annuity is a form of investment that grants the investor a defined series of future payments. These payments will be paid out regularly with specified intervals. A person that receives payments from an annuity is called the annuitant.

Some of the most common forms of annuity in the United States are pensions from retirement annuity contracts and personal pension plans. Insurance settlements are also sometimes paid out as annuities and some lotteries offer the winner annuities instead of a lump sum of money. Banks, insurance companies and other financial institutions can provide you with an annuity in exchange for lump sum of money up front. This type of annuity can provide a person with a regular income for the rest of his or her life, starting from a pre-determined date such as when that person retires or turn 55 years old.

When you discus annuities it is important that you distinguish between immediate annuity and deferred annuity. The first form of annuity was the immediate annuity. This type of annuity has existed for at least four centuries. An immediate annuity is a way of distributing savings. Today, the so called deferred annuity is also very popular but this form of annuity is chiefly a way of accumulating savings that will later be paid out as annuity. The basic idea of the immediate annuity was that you could trade a larger asset in exchange for regular payments. A person that had acquired some money could by an annuity in order to secure his future. Immediate annuities were one of the first forms of pension, since a person could purchase an annuity and be sure to receive periodical payments. With an immediate annuity, the annuitant will receive a series of level or fluctuation periodical payments. The first forms of immediate annuities were paid out annually, hence the name, but today you can choose more frequent intervals as well. Many annuitants prefer to receive monthly payments rather than a larger sum once a year from their immediate annuity. The immediate annuity will pay out money during a predetermined period. This period can be determined in years, such as 10 years, or be the rest of an individual’s life. Since the immediate annuity is not chiefly a way of accumulating money but rather a way of distributing already existing means, an immediate annuity can for instance be purchased when a person is about to retire.

An immediate annuity that is purchased in order to provide someone with a pension is usually a so called “Life Annuity” or “Lifetime Annuity”. This type of immediate annuity is typically purchased from an insurance company. The lifetime annuity can be understood as a loan from the annuitant to the insurance company. The annuitant will pay the insurance company a lump sum of money, and the insurance company will later pay this money back with interest. Instead of having a fixed percentage as interest, the amount of money that will be paid back will depend on the life span of the annuitant. If the annuitant lives a long life, the annuitant will receive more money than if he or she had lived a shorter life.

You can modify an immediate annuity to suit your personal situation. A couple can for instance purchase an immediate annuity that will continue to pay out as long as one of them is alive. You can also choose to have a predetermined minimum guaranteed payment period that will not be affected by the death of the annuitant. It is also advisable to discuss if you want your payments to rise with a fixed amount each year or be escalated by inflation.

When you choose between different immediate annuities you should be careful and always read even the fine print. Some immediate annuities come with very high sales commissions while others have large and undesired expense ratios. You should also check if there is any penalty for early withdrawals. Most immediate annuities will have penalties for early withdrawals, but the size of the penalties can differ considerably.

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