An annuity is a contract sold by an insurance company that is traditionally intended to provide a guaranteed sequence of payments, at an established size and frequency, to the holder. This often takes place during retirement years. Annuties are more recently used as a vehicle to accumulate funds free of income and capital gains taxes (only during the accumulation phase) and take lump-sum withdrawals instead of the guaranteed distribution of income in fixed payments over time.
Annuity contracts were designed to provide a definite supply of income until a final date or the death of the person named on the contract. Taxes are only applied when the holder begins to take distributions or if they withdraw funds from the account. Common forms of annuities are fixed, variable, and indexed annuities. Variable annuities have features of both life insurance and investment products and have a chance of greater return due to the lack of a guaranteed payment. Conversely, fixed annuities provide a definite payment amount. Both are relatively safe with low yielding investments. Indexed annuities yield returns on your contributions based on a specified equity-based index. Annuities also come with death benefits. If the owner dies during the accumulation phase, his/her beneficiaries will obtain the gathered sum in the annuity. This money is then subject to taxes. Annuities have two phases: the deferrral and income phases. The first phase, deferral, is when the participant deposits and accrues money into an account. The second phase, the income phase, is when the participant receives payments over a period of time. Annuity contracts that have a deferral phase always have an income phase. These are called deferred annuities. Some annuities only have an income phase and no deferral phase; these are called immediate annuities. The majority of modern annuity contracts are used to accumulate funds free of income and capital gains taxes, then to later take lump-sum withdrawals without using the guaranteed-income-for-life feature.