What is an Annuity?

Annuities are sold by insurance companies, so naturally they sound very complicated and confusing. Do not panic over semantics. Once you understand the definition of an annuity, you can analyze one to figure out if it is a good deal for you, or just an opportunity to lose money.

Annuity Definition

Google the term "annuity" and you will find many definitions and options. What few get to is the heart of what an annuity actually is. An annuity is a loan that you make to an insurance company. Surprised? That is because they do not call it that, they call it an 'insurance product'. Insurance is something that you buy to protect you in case something bad happens.

Bond vs. Annuity

A bond is a loan that you make to a company that they pay you interest on over the term of the bond. In the case of bonds, the debt is secured against the company. This means that if the company goes bankrupt, you are one of the creditors in line to get paid. By calling an annuity a "product," you move far back in line for collecting if a bankruptcy occurs. This does vary by state law, so check out the laws for your state. Do your homework. An annuity is only as good as the company that sells it.

If you think of an annuity as a loan, then the different types will make a lot more sense. By choosing a "type" of annuity, you are choosing a level of risk with which you are comfortable. You can be aggressive, by choosing a variable annuity, or very conservative by choosing a fixed annuity.

Regulations Govern Annuities

There are many regulations that govern annuities, at both the state and federal level. These regulations will affect how you can be repaid. Your financial planner will help you figure this out. Research your annuity like any other product. You paid attention when you bought your house, so pay attention by carefully reading your annuity agreement as well.

Principal and Interest

Since it is an investment, you will have to pay taxes on your gains. Thanks to the federal government and some very long laws, these gains will usually not be taxed until you retire and start getting paid. Your retirement income will likely be less than your working income, so your taxes will be lower by paying during retirement.

Additionally, not all of your payment will be considered "income." Like your mortgage payment, some of each payment is principal and some is interest. If you were already taxed on the principal, you will not be taxed on this again. Tax law changes every year, so check with your financial advisor. Annuities are an investment, and like all investments some are better than others. Read everything carefully and consider what you are buying and you will do well.

For some people, an annuity can be the answer to their retirement financial fears. To other people, annuities are a bad deal. If you are not a CPA, you will probably not know which group you fall into. That's okay. Talking to someone who knows will reveal your best strategy.

Non-retirement Annuities