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What is Annuity
Although many people are just now learning about annuities they are in no way a new invention. In fact, depending on which sources you read they can trace back to the early Roman Times. The first annuities were created by the Roman Empire and followed up in the 17 century by the European government. Both investments called, “Annua” and, “Tontine” respectively, paid the purchaser (the citizens at the time) an annual payment in exchange for an up-front lump sum. This was done at the time primarily to raise immediate funds for wars and battles.
The first American company to offer annuities to the general public was the Pennsylvania Company for Insurance on Lives and Granting Annuities. After that, just about every insurance company began to offer annuities and the market for them began to increase in popularity. It was in the 1930’s when their growth began to skyrocket; as the economy went into a depression people turned to insurance companies to offer them guarantees of retirement income as well as peace of mind.
The original annuities were quite simple given the industry today. An individual would give an insurance company a lump sum payment in exchange for a fixed interest rate of return. When it came time to withdrawal money from the annuity, the individual could choose to receive income for life, for a set period of time or over a set number of years. The annuities of the 1930’s are very similar to what we know now as Immediate Annuities.
What has always been attractive with annuities is the ability to defer taxes on the earned interest. Because annuities are issued by insurance companies, all of your earnings accumulate tax-deferred, putting the time value of money on your side.
Today, the annual sales of annuities are estimated at $200 billion dollars, with most people finding comfort in the safety and security.
A fixed annuity is an insurance contract where the insurance company pays you a guaranteed fixed rate for a specified period of time, after that time is up you are free to take your money and the interest you earned. There are two types of fixed annuities: CD Type Fixed Annuities and Traditional Fixed Annuities. CD Type Fixed Annuities work similar to a CD paying a stated percentage rate for every year you are in the annuity. Traditional Fixed Annuities pay an interest rate that can fluctuate depending on where interest rates are, but can never go below the guaranteed amount. When in a fixed annuity, both CD Type and Traditional Fixed, your money generally is not completely tied up; most fixed annuities allow you to withdraw up to 10% or 20% each year. Also, many fixed annuities allow you to pull the entire amount out if you spend time in a hospital, become terminally ill, or pass away.
An immediate annuity is an annuity where an insurance company guarantees you a fixed rate of interest for a certain term or until you pass away - whichever is longer. The rate in an immediate annuity is generally substantially higher than in fixed annuities because after you pass away, or after the term ends, the insurance company stops the payments.
Typical, immediate annuity terms would be Life with 10 year period certain; in this case the owner would get payments for Life or 10 years, whichever is longer. If the owner passes away in 2 years, their beneficiary will receive payments for the 8 remaining years. If the owner lives for 20 years, the insurance company will make payments for all 20 years and payments will stop at death. The interest rate that an immediate annuity pays differs depending on whether the owner is male or female as well as the age of the person.
Equity Indexed Annuities
An equity-indexed annuity is an annuity that offers a guaranteed base rate of interest, usually lower than a typical fixed annuity but has upside potential linked to the stock market. The big difference between a fixed annuity and an equity-indexed annuity is that an equity-indexed allows you to link your annuity to a stock market index such as S&P 500. Even though your annuity is tied to a stock market index, you will never earn less than the base rate you have been guaranteed - even if the market goes down; however, when your index goes up there will be an upside limit which limits the amount of interest you can earn to usually 8-10% per year.