The Basics of Annuities

Annuities are a plan to invest a lump sum of money in return for an annual (or more periodic) payment. Annuities allow someone to invest the money once in an annuity and receive a set payment or minimum and maximum rate of return. Below are some pros and cons of annuities, and information about taxes and the law as they pertain to annuities.


* Annuities permit those who do not have investment experience to make more on their money than letting it sit in a bank account.

* Because annuities pay out a minimum or set amount per month, quarter or year, the individual knows either how much they must live upon or a given range of payments with a minimum or maximum. When investing in a 401K or IRA, the recommended amount to withdraw is 2-4%, but the value of the lump sum from which you can pull fluctuates wildly.

* One of the main benefits of annuities is the protection of principal.


* Annuities can involve strict limits on access to the principal lump sum. Withdrawing from the invested lump sum risks financial penalties, even though it is your own money. This problem can be mitigated by not investing all of your money in the annuity and setting aside a large emergency fund to use for major medical bills, surprise home repairs or buying a replacement car.

* Annuities with some investment firms charge extremely high fees.

* Annuities can theoretically return less than the maximum rate of the stock market.


When you put a lump sum into an annuity, the lump sum will grow with dividends or interest payments. When you begin to receive distributions from the annuity, the payments can be limited to a percentage of the returns or dividends plus some principal.

If you receive annuity distributions that include part of the principal, income taxes are only owed on the remaining percentage of the distribution. If you elect to receive annuity payments pulled only from the investment returns, then the entire annuity payment is subject to income tax.

The Law

Annuities can be set up to continue distributions from one spouse to another after their death or distribute payments to another family member. An annuity in this arrangement is not subject to the federal inheritance tax, though the recipient must pay income taxes. Charitable trust annuities give the principal lump sum to charity upon your death, while you receive the interest or investment returns for the rest of your life. This ensures those assets go to the charity as desired and reduces estate complexity, since the executor does not have to transfer these assets to the charity.

If you are considering annuities as part of your investment portfolio, it is best to talk with a financial advisor to determine whether this form of investment suits your particular situation. Although there are many advantages to annuities, the pros and cons in terms of specific your circumstances must be carefully weighed.