'Annuity' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
An annuity is an investment contract that an insurance company sells to individuals. This agreement promises that it will make a regular series and dollar amount of payments to the buyer. This can be either for the rest of his or her life or for a set amount of time. The payments out are typically made after the individual retires.
Annuities have a long past that began in the Roman Empire. Roman citizens could purchase annual contracts from the Roman Emperor. The empire would then make annual payments to the citizens for the remainder of their lives. European governments revived the sale of annuities in the 1600s. They sold lump sum contracts to investors to help pay for expensive wars.
These investors also received a number of prearranged payments back from the governments that sold them. Annuities in America started as a way to support church ministries. 1912 saw the first annuity contract that was offered to the general American public by a Pennsylvania life insurance firm. These contracts continued to evolve and grow throughout the 1950s until they became commonplace in the 1980s.
Annuities offer certain tax advantages to their owners. Annuity holders only pay taxes on their contributions when they begin to take withdrawals or distributions from the funds. Every annuity contract is tax deferred. This signifies that investment earnings in such annuity accounts continue to grow tax deferred until the owners withdraw them. This also means that annuity earnings may not be taken out without paying a penalty until the owner reaches the set age of 59 1/2.
There are two general types of annuities contracts. Fixed annuities pledge to provide a guaranteed payment amount. Variable annuities do not make this guarantee. They do offer the possibility of earning higher returns in the variable annuity. Experts consider either type of annuity to be a safe but low yielding investment vehicle.
Annuities have a specific purpose. Companies developed them in order to insure the owner against the possibility of living longer than his or her retirement income. This is known as superannuation. The idea behind annuities is to help offset this risk of outliving retirement funds.
Annuities are popular with conservative investors because they continue to make payments until the holder dies. Even when the payments surpass the amount that remains in the annuity, the payments continue to be made. They are always counted as retirement savings vehicles.
The two phases of annuities are the accumulation and the distribution periods. During the accumulation phase, owners do one of two things. They can make a large lump sum payment into the annuity. They may also make regular payments into the contract. If the owner dies in this accumulation period, the heirs are given the amount of money that the owner paid into the annuity contract. Taxes owed would include estate taxes and regular income taxes.
When the owner reaches the retirement age, annuitization happens and distribution begins. At this point, the accumulated amounts convert into annuity units. The owner is changing the lump sum amount in the contract for the guaranteed series of payments. At this point he or she no longer has access to the large single amount in the account. The guaranteed income for life begins in this distribution phase.
Owners can receive their benefits as one of several options. Straight Life contracts pay calculated sums that are only based on the owner’s life expectancy. These payments stop when the owner dies even if a lesser amount than the contract value is distributed. Life with Period Certain option makes payments for a minimum amount of time up to the death of the owner. Joint Life option pays benefits until both owners have died. Joint Life with Period Certain option gives payments for a guaranteed minimum amount of time until both owners have died.