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Annuity

The concept “annuity” is applied to an insurance contract produced and extended by monetary institutions with the purpose of repaying committed facilities in a fixed income in the period ahead. Investors put up their capital and acquire annuities with monthly bonuses or lump-sum payments. In other words, the annuity turns into account for retirement objectives and assists persons in considering a risk to outlive their money holdings.

Operating principle

To receive retirement payments without waiting for the official exit to a well-deserved rest - this opportunity is provided by a pension annuity. Although the name contains the word "pension", this instrument belongs to the field of insurance.

An annuity means a funded instrument that gives its owners a guaranteed income in old age. Notably, a potential client of this benefit must have accumulated a minimal sum. So, the annuity is aimed at providing a sustainable cash flow and alleviating concerns of outliving the assets. Of course, there is a possibility that the amount of these assets won’t be enough to maintain the standard of living of an individual. That’s where annuity comes into play. 

As long as committed facilities are illiquid and become due to withdrawal fine, it’s a bad practice to use these means for young people and individuals seeking for liquidity.

In fact, the annuity passes through particular stages and time intervals that are the following:

  • An accumulation period. It’s a time interval, when a person is trying to save money for retirement, or another long-term goal. Investors must ensure that they raise enough money to meet their forecasted demands during the following period.
  • An annuitization period. The phase presupposes a payout. The accrued funds are converted into an income stream.

Most annuity products are classified as deferred, which means that market players do not receive an immediate return on their investments. Thus, an accumulation period may last for several years, or even decades. The contract buyer is able to make recurrent contributions to the annuity at this stage. In some countries, the national government, or the contract holder's employer may also contribute to the account. These funds are invested either in securities, such as stocks and bonds, or in savings accounts that pay interest.

Some financial tools may be qualified as immediate. The instances include a lottery prize or other settlements. This type of annuity is usually exchanged for monetary flows in perspective. 

The SEC maintains supervision over all annuity products, along with the other regulatory body, the FINRA. Market agents that put annuities up for sale are expected to have a life insurance license given by a state, as well as a license of securities, when it comes to variable ones. In this regard, the agents receive a commission that depends on the annuity’s cost. 

Specific notes

A surrender period of the annuity enters into force meaning that there is no way to withdraw financial facilities until a particular date. It’s a reason for investors to give consideration to significant purchases as monetary means won’t be distributed from their annuity. 

Moreover, annuity contracts may possess an income rider. It guarantees a fixed return after their start. Therefore, the age of generating income needs to be precise as it influences payment conditions and interest rates. Some companies also have charges depending on the annuity contract. 

Note: defined benefit plans, along with Social Security are known as two instruments of underwritten life-long annuities that guarantee a stable cash flow for retirement individuals. 

While lots of annuity products and retirement accounts are individually owned, certain companies sell accounts that can have multiple holders. As a rule, these products are put up for sale in pairs, so that both owners are able to make periodic contributions. Typically, the keepers retire at about the same time, and both rely on account payments as their primary or secondary source of income. Some people even buy long-term annuity and make deposits to create a future income generator for their children or beneficiaries.

Annuity division

In fact, annuity contracts are distinguished by a broad range of factors, for instance, a time duration. These financial tools can be established in order to receive payments as long as the annuitant or their party to marriage is alive. In this case, a fixed interval of payoffs is presupposed, aside from the lifetime of the annuitant.

Deferred annuity. It is a type of contract that allows periodic contributions to a plan, but does not allow any withdrawals until the allotted time has been reached, or a specific event has occurred. For instance, a deferred annuity plan may be placed early in life and receive payments on a regular basis before retirement. At this point, contributions stop, and the account holder begins receiving regular income payments that are funded from the balance in the pension plan.

Immediate annuity. It is paid right after the receiver of an annuity introduces a lump sum. Notably, this type of annuity, along with a deferred one, contemplates that the principal amount of funded facilities may or may not be reclaimed. If there is a life-term payment, invested money isn't refunded in the case of an annuitant's death. In a reverse situation, when a time interval is fixed, the annuitant’s heirs, or a party to marriage is able to obtain invested assets.

Benefits and risks

A key advantage of annuity contracts is that there are no restrictions on the amount of annual contributions. This means that an individual has the opportunity to save large sums of money, while deferring the payment of taxes. The balancing factor is that while getting financial facilities back, they will be taxed like ordinary income.

Any investment involves a certain level of risk, so before entering into a contract, it is necessary to check the financial condition of the insurance company issuing the annuity.

Real life examples

Most recently, the trend to purchase annuities covering two or more individuals has gained traction in different countries.

So, a joint retirement annuity in the United States provides an opportunity for close relatives or spouses to pool their savings and receive lifetime benefits. Waiting for the official release to rest is no longer needed. Couples can use this product if one spouse does not have enough pension savings to buy a retirement annuity, while the other has a surplus.

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