An annuity is a type of investment which helps the investor make payments (single or installments) over a defined period of time (years) and in return receive a specific amount at fixed intervals (annually, semi-annually, fixed number of years etc.). Post the demise of the annuitant or post the fixed number of years, the fund created through the annuity payments is refunded with a certain additional amount depending on the amount offered by each organization. (Williamson, 1998) Annuity is generally long term in nature and guarantees income for a certain period of time; so mostly an individual looks at annuity to generate income during the retirement period. Tax benefits are also reaped by the investors (Web source 5). There are different types of annuities with different cost and properties. The most common forms of annuity are as follows:
Immediate annuity & deferred annuity: The immediate annuity is generally paid in full at the very beginning and the pay outs in are provided immediately. The payments may be made for life or for a specified number of years. People with a large inheritance or a lump sum amount acquired from retirement mostly invest in them. Since the payout amount and duration are assured by contractual binding an investor feels secure with the investment. (Web source 4) A deferred annuity although defers the payout by a specific period to a certain date in the future. The investors make payments on regular basis until the maturity period is reached. The payouts are later started at the future date at the assured rate of return for a specific time frame. An individual would ideally want the deferred annuity to mature around the time of his retirement, and the payments would be planned as to last till his death. (Web source1)
Fixed annuity & variable annuity: A fixed annuity guarantees a specified rate of return over a certain time period. The fixed annuity can therefore be compared to other relatively risk free instruments. Although the interest rate provided is not as high as the rate provided in the market (stock or mutual fund). Also the fee is relatively high so the cost benefit analysis should be done before investing in the same. (Web source3) A variable annuity on the other hand provides a rate of return which varies according to the value of the underlying instrument. The investor can select from various stock, bond or money market, so he may vary the level of risk and diversify his investment as he wants. (Williamson, 1993) So an investor who wants to make profit from market fluctuations and rise will be more attracted to this form. (Web source2)
Some other types of annuities are:
Equity-Indexed annuities: these are a blend of fixed annuities and variable annuities which has an assured rate of interest and a variable component as well. So this helps the investor to profit from strong markets and they are guaranteed a minimum fixed income too. (Adkisson, 2006)
Life annuity: it provides payouts through out the life of the person investing in the annuity.
Life with cash payment: it also pays the annuity holder for the entire lifetime but if the annuitant dies, then the beneficiary will receive the amount paid in but not repaid.
Life with term certain: it pays the annuitant throughout his life and after his demise the amount is paid to the beneficiary for the remaining time period.
Joint and survivor: it provides income through the life of the annuity holder and a specific survivor mentioned (generally spouse), but the amount of payout usually decreases post one deceases.
Lump sum: it provides one time lump sum payment to the annuitant (Web source 6)
1. Williamson K.Gordon, 1998, Getting Started in Annuities, Wiley
2. Adkisson Jay, 2006, Equity Indexed Annuities: the Smart Consumer’s Guide, iUniverse, Inc.
3. Williamson K.Gordon, 1993, All about Annuities: Safe investment havens for high-profit returns, John Wiley & Sons Inc
Web source1: http://annuities-explained.net/types-of-annuities/
Web source 2: http://www.annuityforlife.com/types-annuities.htm
Web source 3: http://www.insuremagic.com/content/PlanInfo/Life/pen_annuity.asp
Web source 4: http://tna.europarchive.org/20081113042840/http:/www.hm-treasury.gov.uk/d/pbr06_annuities_293.pdf
Web source 5: http://www.quotit.net/resources/annuities.pdf
Web source 6: http://www.usboomers.com/annuity_basics.htm