While scrolling through the financial products provided by your banker, you must have come across the word annuities, but do you know this product is and how it works? If not, we are here to help you give a basic understanding of what an annuity is and how it works.
What Is An Annuity?
Annuities are financial products that help people plan for their retirement. This financial product helps in multiple ways but they are specially designed for those who are willing to have a steady income even after their retirement.
In more specific terms, an Annuity is an agreement between a consumer and an insurance company with an aim to plan for retirement.
The insurance company provides the investor a tax-deferred growth on their investment and promises to pay a regular income during the days of the investor’s retirement. The income that retirees will receive after retirement is predefined by the insurance company. The insurance company may pay a lump sum amount or it may pay monthly income for the owner’s rest of life.
How Do Annuities Work?
Annuities work quite similarly to other types of insurance. The purchaser pays a premium to the insurance company while the insurance company agrees to fund him after his retirement.
In case of the investor’s death, the annuity will end and the insurance company is liable to pay the remainder of the cash value to the investor’s beneficiaries. Following the amount of risk involved in it, annuities are considered actual insurance products.
The annuities function in two basic phases, the Accumulation phase, and the distribution phase. As the name suggests, the accumulation phase is the period when the annuity keeps growing. It is the phase before your retirement and your investment keeps growing.
The second phase is termed as distribution phase, which also is quite self-explanatory. During this phase of an annuity, the money accumulated in the first phase is converted into a series of payments. This is the phase after retirement and the investor will be paid the entire funding in a lump sum amount or he keeps getting monthly income for the rest of his life based on the terms agreed at the time of agreement.
What Are The Benefits Of Annuities?
Annuities offer three major benefits to retirees. If you are eyeing buying an annuity, you will get the following major benefits from this type of investment.
Number One: Secured Future
The ultimate aim of an annuity is to provide a secure future to the retiree. Upon agreeing on an annuity, the investor will get a steady income flow for his life after retirement.
So, the major benefit of annuities is, the annuity buyer will be given guaranteed income after his retirement, and his life after retirement will be secured.
Number Two: Tax-Deferred Growth On The Investor’s Income
The second benefit that annuities offer is, the investment grows tax-deferred. It means that the investment will keep growing without being taxed until your first withdrawal will be made. It functions similar to the IRA, 401K, and Pension plans.
Tax Deferral refers to the benefit provided by the Internal Revenue System following which the investor gets tax relief on investment gains until the investor makes the first withdrawal for income purposes.
As the investor receives his first annuity payment, his income will be subject to ordinary income tax.
Number Three: It Also Helps You Cope With The Increasing Cost Of Long-term Care
Another benefit that annuities provide is, they offer long-term care insurance. It helps the investor cope with the increasing cost of long-term care.
Some annuity providers have even come up with deferred annuities that offer tax-free benefits on covering expenses of assisted living and nursing homes.
What Is The Difference Between A Life Insurance And An Annuity?
Annuities and life insurances have multiple differences. In simple words, insurances are entirely the opposite of annuities.
The major difference between an annuity and life insurance is, life insurance is designed for security against pre-mature death while an annuity is a financial tool that helps secure your life after retirement and is used to secure you against longevity.
Further, life insurance requires the beneficiary to periodically pay into a contract that promises him to create an estate.
Life insurance helps the beneficiaries leave resources for people they love, while the annuities secure your life after retirement.
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The Bottom Line
It is important to note here that, there are multiple annuity options for you to choose from, thus selecting a worthy annuity should be your utmost priority. Shop around all the available options and decide on one that best meets all your financial goals.
