An annuity is simple a series of periodic payments. It is a contract guaranteed by an insurance company that promises to make a series of payments for a fixed period or over someone’s lifetime. A premium paid either in lump sum, flexible or periodic payment schedule is paid to the insurance company in advance.
Why would I want to buy an annuity?
For those who are risk adverse and want their money guaranteed, an insurance company can provide a fixed annuity that pay a fixed interest rate much like a Certificate of Deposit. Annuities also provide retirees that want a steady guaranteed payment like a pension or social security payment the same functionality and safety.
Annuities provide tax deferred accumulation for a fixed annuity and tax-sheltered growth for a variable annuity. Annuities also provide tax sheltered income and in the case of variable annuities tax sheltered growth. Annuities are also protected from creditors. The insurance industry has a tremendous lobby to protect these types of contracts from legislative change as well.
Insurance companies go bankrupt, what happens to my money or my insurance contract if that happens?
First insurance companies reinsure each other to further diversify the risk. Second, the state where the insurance company is domiciled steps in and transfers all existing contracts to another insurance company to continue the benefits and guarantees. But there is a limit. There is not an FDIC like in the banking industry. The state will have a limit of approximately $300,000 of cash value that will be covered in the event the insurance company has zero assets or reserves left, this will vary from state to state and is not a hard amount.
How do you know this?
I have experienced several insurance companies failing in the past.
What is the difference between a fixed annuity and a variable annuity?
A fixed annuity pays a fixed interest rate based upon the underlying bond portfolio owned by the insurance company.
For customers who are willing to take on more risk, a variable annuity has sub accounts that invest in the stock market and the bond market directly. The sub accounts are much like a mutual fund, but we are not allowed to call the sub accounts a mutual fund.
What is a surrender charge?
When you by an annuity the agent is paid a commission. There are also expenses incurred by the insurance company when establishing the contract. And to keep the underlying bond portfolio from being disturbed (selling bonds to provide cash for early surrender) insurance companies set in the contract a surrender charge to cover these expenses. Basically, if you intend to buy an annuity, you need to be prepared to hold it for a very long time.