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What is an Annuity?

An annuity is a contract between the contract owner and an insurance company in which the purchaser makes a payment (or series of payments) to the insurer in exchange for the right to receive regular payments, starting either immediately or at some time in the future.

The most common purpose of an annuity is to provide a stream of income during retirement, either for a specific period of time or over the rest of the beneficiary's lifetime. An annuity with a lifetime benefit is often characterized as the opposite of life insurance because the purchaser is economically better off (and the carrier worse off) when the beneficiary lives longer than expected.  There are several different kinds of annuities.  An immediate annuity typically involves the payment of a lump sum amount to the insurer in exchange for payments that begin immediately.  A deferred annuity is a type of annuity which is purchased now, and which provides benefits starting at some time in the future.  With a deferred annuity, funds grow on a tax-deferred basis, and like contributions to a qualified plan (e.g., 401(k), 403(b) plan), can only be withdrawn without penalty after age 59.5. Types of deferred annuities can include fixed, variable or index annuities.  A fixed annuity typically is invested by the insurance carrier in its general investment account providing stable consistent returns, while a variable annuity offers the ability to invest in mutual fund type funds in the policy's "separate account" whose value rises and falls with the underlying investments chosen by the annuity's owner.  Indexed annuities offer yet another popular flavor of deferred annuities whose investments move in conjunction with a market index.

A qualified longevity annuity contract (QLAC) is a special kind of deferred income, fixed annuity which has no cash value that pays a lifetime benefit no later than the beneficiary's 85th birthday.  It is "qualified" because up to certain limits, a purchaser of a QLAC may use qualified retirement account assets to purchase the annuity.  Monies invested in a QLAC are not subject to required minimum distributions after age 72.

Ron Ryan

Ron Ryan is the author of this solution

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Updated on Wed, 29 Jan 2020

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