What Is An Annuity?

An annuity is a long-term contract with an insurance company. Its primary purpose is to ensure that your retirement income lasts as long as you do. In its simplest form, a single premium immediate annuity (SPIA), you pay the life insurance company a single premium and it pays you a fixed monthly amount for the rest of your life. You can also use annuities to accumulate money for retirement on a tax favored basis. These contracts are called deferred annuities because you defer the payout while the funds accumulate at some fixed rate. The annuity can specify that the rate is guaranteed for any time period, generally one to 20 years or to when you attain retirement age.

So, how is a deferred annuity different from a bond or a bank CD? First, you have the right to annuitize the contract and get lifetime payments. Also, the value accumulation in the annuity is not taxed until it is paid to the annuitant. A bond coupon and CD interest are taxed when they accrue regardless of when they are paid. The exception would be municipal bonds which are mostly tax free. Finally, annuities can be exchanged at any time for other more attractive annuities without tax. Like a bank CD, an annuity contract often contains penalties and charges if you surrender or exchange the annuity before the guarantee period has ended.