Annuities are an investment agreement between you, the investor, and a company that provides annuities which is typically an insurance company. In this agreement you agree to give them a set amount of money either all at once or over time and they agree to pay you regular payments totaling the amount you invested plus an additional rate of return for a specified period of time. Typically annuities are used by investors to supplement retirement income on a monthly basis.
Perhaps the biggest benefit of annuities is that they are tax deferred. What that means to you is that all the money you contribute and any gain you make on your investment is not taxable until you begin receiving payments. Once you receive payments only the gain on your money is taxed. It should be noted that the income is taxed at a regular tax rate however, not at a capital gains rate like other investments.
Another big benefit is that annuities are guaranteed as long as the company you dealt with stays in business. Not only are your payments guaranteed but you will continue to receive them until you pass away, regardless if that amount is more than you originally invested.
On the negative side fees for annuities can add up quickly, and they tend to have higher fees associated with them than most other investments like mutual funds. Not every annuity will have a lot of fees though, so be sure to read your paperwork before investing.
There are a few types of annuities that you can invest in. The most common type of annuity is a deferred annuity that provides a fixed rate of return on your investment. This amount will vary depending on which annuity company you work with and what the market conditions will bear. An example of this would be an individual who invests $100,000 in exchange for a 7% interest return. This investor would receive regular installments of principal and interest spread out monthly from his retirement until he dies
The problem with fixed rate annuities is that they don’t take advantage of thriving market conditions and that is why some investors prefer variable annuities instead. Unlike fixed annuities, variable annuities are tied to some other type of investment like stocks, bonds, mutual funds, ETF’s etc or a mix and match of all of them. The rate of return on these annuities is tied to the performance of these investments which allows the investor to get a higher rate of return instead of relying on the fixed rate. The downside of this of course is that stocks, bonds, mutual funds etc can and often do lose money so you are taking a bit of a gamble investing with them.