Annuities: Start By Learning The Basics

Annuities can seem complicated to the average investor. There are so many types of annuities that it can seem a daunting task to decide if an annuity is a good option for you, and then to choose the right one. Here is some basic information on how annuities work.

AN ANNUITY IS A CONTRACT, in its most basic form, between an investor and an insurance company (insurer). The investor purchases an annuity, either by paying a lump sum or by making regular payments, and receives principal and interest back from the insurer, based on the terms of the contract.

ANNUITIES HAVE TAX ADVANTAGES One benefit of annuities is that earnings grow tax-deferred and are not taxed until you withdraw them, similar to an IRA. However, there are penalties if withdrawn early (prior to age 59-1/2). In a nonqualified annuity—one that is not part of a retirement plan—contributions are not tax-deductible.

HOW TO PURCHASE ONE You can purchase an annuity from any licensed financial planner or insurance agent. Do your research first. Always check the ratings of the insurance company. Because it is a contract, many annuities have surrender fees for early withdrawals. Ask for an itemized list of all fees associated with the purchase. Make sure you understand how the product works: if you can’t understand it, don’t buy it.