An annuity is an agreement for one person or organization, typically a life insurance company, to pay another person a series of guaranteed payments. One of the major benefits of annuities is that they offer tax-deferred growth of earnings, allowing the assets therein to compound at a faster rate than if taxes on gains were imposed.
Generally speaking, there are two types of annuities - fixed and variable:
Annuities also offer a number of other features such as death benefits, living benefits, and other guarantees to make the products more attractive to investors. Some of these features are included within the standard costs of the annuity, while others – referred to as a Rider - may carry an additional fee.
- Fixed annuity - the insurance company guarantees the following: your account will earn a minimum rate of interest; periodic payments will be a guaranteed dollar amount; and these periodic payments will last for a certain amount of time.
- Variable Annuity – assets placed in the annuity are invested among a range of different investment options, generally mutual funds. The rate of return and the amount of the periodic payments one eventually receives vary depending on the performance of the investment options selected.
Annuities can be an excellent investment solution for some individuals, not such a good idea for others. Advisors need to exercise prudent suitability standards when making recommendations to clients about the use of annuities as a retirement savings vehicle.
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