What is an annuity?

An annuity is a contract between you and an issuer whereby you agree to give the issuer principal and in return the issuer guarantees you fixed or variable payments over time. While annuities are not insurance policies, they are issued by insurance companies..

An annuity is similar to a retirement plan in that you can fund it in a lump sum or a little at a time, and all capital in an annuity grows and compounds tax-deferred until you begin making withdrawals. Unlike retirement plans, however, there is no limit as to how much you can invest in annuities!

The large number of annuity products on the market today can make selecting the most suitable annuity a confusing process. But in fact, there are only a handful of different types of annuities. When selecting an annuity you will be presented with essentially three choices:

Timing of payout -- immediate or deferred: In an immediate annuity, the investor begins to receive payments immediately upon investing. This is for investors who need immediate income from their annuity. In a deferred annuity, the investor receives payments starting at some later date, usually at retirement.

Investment type -- fixed or variable: Fixed annuities are invested primarily in government securities and high-grade corporate bonds. They offer a guaranteed rate, typically over a period of one to ten years. Variable annuities enable you to invest in a selection of sub- accounts, such as securities portfolios, fixed interest accounts, and money market securities. These sub-accounts are tied to market performance, and often have a corresponding managed investment portfolio after which they are modeled.

Liquidity options: Most annuities allow you to withdraw either your interest earnings or up to 15% per year without a penalty (although any withdrawal from an annuity may be subject to taxes and a 10% federal penalty if taken prior to 59? years of age). Most annuities have a surrender charge -- a penalty for making an early withdrawal above the free withdrawal amount. Typically this surrender charge decreases over a seven-year period. Some annuities with surrender charges reward the investor by offering a ?bonus?: the insurance company adds on average 3% to 5% to the amount of your principal . Bonus annuities typically have slightly longer surrender periods, and some charge a slightly higher fee than they charge for their standard annuity. For investors who may need spur-the-moment access to their money, there are also annuities without any surrender charges -- these annuities do not offer bonuses, and may also charge a slightly higher fee than the standard annuity, in exchange for 100% access to your money.

While there are many advantages to annuities, they are not right for everyone. Click here to see if an annuity is right for you.