Guide For Annuities And Annuity Rates

By Jason Dell

Annuities are contracts where an insurer makes monthly income payments to the annuitant based on a bigger lump sum amount previously paid in. This income stream can be deferred or taken immediately, and the interest rate provided can be variable or fixed. The income continues for a set duration or until the annuitant's death.

Some annuity contracts call for a single lump sum to be paid to the insurer, while others may allow customers to increase the account's value with regular contributions. This second option is a popular retirement plan afforded tax-deferred status. Both contributions and earnings that accrue are allowed to grow without being taxed.

These and other variations allow for a significant number of annuity types. The simplest model is that the insurer gets a single lump sum amount, and immediately starts making monthly income payments to the annuitant for a set duration. This kind of contract is sometimes needed to fulfill obligations associated with legal settlements. But more often than not, it is used by the newly retired who are suddenly able to withdraw big amounts from their qualified retirement plans.

In this case, the part of the income stream that is principal being returned to the annuitant is not taxed. Only the earnings in the account are taxable as income. Note that the tax rate is based on income, and not capital gains.

The second and more popular type of contract is a deferred annuity. Annuitants can make a lump sum payment or there is an accumulation phase where the account's value grows with tax-deferred contributions and earnings. The distribution phase begins on a specified date, and the payments made to the annuitant are now considered as taxable income.

The best option for ordinary investors trying to pad a retirement nest-egg is a deferred annuity for life with a fixed rate and beneficiary protection. The insurer guarantees a fixed interest rate for funds in the account, which grow faster because of the tax-deferral. It guarantees a decent income for life after retirement. If the annuitant dies before the distributions start, the beneficiary is guaranteed to get a specified amount.

Variable rate annuities are more suitable for investors who need faster growth and want to invest more money than can be contributed to qualified plans like a 401K. Investors can pick and choose from a selection of options like mutual funds, which can hold a portfolio of bonds, stocks, money market instruments, etc. It's important to ensure that a variable annuity contract offers a minimum guaranteed rate of return, regardless of the performance of the underlying investments.

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