An annuity is a tax-deferred savings account issued by a financial advisor at an insurance company. It usually is part of an overall retirement strategy that can also include income sources such as pensions or even Social Security.
Basically, when you make an investment in an annuity, it makes payments back to you on a future date or a series of dates. The income you receive can be paid monthly, quarterly, annually or in a lump sum payment. Your payment amount is determined by various factors, such as how long you choose to receive payments.
There are several advantages of investing in an annuity as opposed to an IRA or 401(k). The primary advantages of an annuity is that you can invest a larger amount of cash, and you can defer paying taxes on the investment.
Unlike other tax-deferred retirement accounts, annuities are not limited to an annual contribution amount. That gives investors the freedoms to put away more money for their retirement. It is especially helpful for individuals who are close to retirement age and have some catching up to do.
All the money invested compounds year after year without being taxed. The principal return is tax-deferred, and taxes are paid when the funds are withdrawn. In other words, while you are saving, you do not have to pay taxes. As the principal compounds, the amount of cash you have available to earn interest grows.
When the time comes for you to begin receiving payment, you can take a lump-sum payment from the annuity. Generally, most retirees choose to receive guaranteed payments for a specified length of time or even for the rest of their lives.