What is an Annuity?
There are two kinds of annuities:
1. Some annuities help you accumulate funds for a more comfortable retirement - while enjoying the benefits of tax-deferral. These tax-advantaged security boosters are deferred annuities. You can purchase a deferred annuity with one or more premiums paid to an insurance company. You can also add money to an annuity from an existing annuity or life insurance policy without paying current taxes. Check out Tax-Free Exchanges. Annuities defer taxes as a matter of law. You are not buying insurance when you buy a fixed annuity as some people mistakenly think.
Your premiums earn interest, which can be calculated in numerous ways, depending on the plan you buy. You pay tax on the interest earned only when you withdraw your funds. As with other investment alternatives such as Certificates of Deposit (CD's), you may be subject to penalties if you withdraw your funds early. These penalties are called surrender charges. The good news is that you can usually withdraw some percentage of your funds every year without paying a penalty.
In addition to surrender penalties, if you withdraw you funds before you are 59 1/2, you may be subject to a 10% tax penalty like an IRA.
2. The second type of annuity can provide a guaranteed source of income for as long as you wish starting whenever you want. These instant income generators are immediate annuities. You buy an immediate annuity by paying one premium to an insurance company (or converting an existing annuity or life insurance policy). The insurance company sends regular income payments to you or the payee you select. You decide how often the checks will come, and for how long the payments will be made. The regular payout amount depends on the type of immediate annuity you select.
They say that people with annuity income live longer because they never have to worry about outliving their money if they choose a life option.
Also keep in mind that an immediate annuity should be considered as income and not as an asset when applying for special services such as Medicaid. (consult an attorney for more facts).