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An annuity is a contract between you and an insurance company in which you make a lump sum payment or series of payments and in return obtain regular disbursements beginning either immediately or at some point in the future.
The goal of annuities is to provide a steady stream of income during retirement. Funds accrue on a tax-deferred basis, and like 401(k)contributions, can only be withdrawn without penalty after age 59.5.
Many aspects of an annuity can be tailored to the specific needs of the recipient. In addition to choosing between a lump sum payment or a series of payments to the insurer, you can choose when you want to annuitize your contributions - that is, start receiving payments. An annuity that begins paying out immediately is referred to as an immediate annuity, while those that start at a preset date in the future are called deferred annuities.
The duration of the disbursements can also vary. You can choose to receive payments for a specific period of time - for example, 25 years - or obtain them until your death. Of course, securing a lifetime of payments lowers the amount of each check, but it helps ensure that you don't outlive your assets.
Fixed annuities pay out a guaranteed amount based on the balance of your account. The downside of this predictability is a modest annual return.
An important feature to consider with any annuity is its tax treatment. While your balance grows tax-free, disbursements are subject to ordinary income tax. Conversely, mutual funds that you hold for over a year are taxed at the long-term capital gains rate. And unlike 401(k) accounts, contributions to annuities don't reduce your taxable income. For this reason, some financial professionals recommend annuities only after maximizing your contributions to pretax retirement accounts.
*Annuities are designed to meet long-term needs for retirement income. They provide guarantees against the loss of principal and credited interest, and the reassurance of a death benefit for beneficiaries. These guarantees are backed by the financial strength and claims paying ability of the issuing insurance company. Annuities frequently involve substantial charges such as administrative fees, annual contract fees, mortality & risk expense charges and surrender charges. Early withdrawals may impact annuity cash values and death benefits. Taxes are payable upon withdrawal of funds. An additional 10% IRS penalty may apply to withdrawals prior to age 59 ½. Annuities are not guaranteed by FDIC or any other governmental agency and are not deposits or other obligations of, or guaranteed or endorsed by any bank or savings association.