Legal Definitions - annuity

An annuity is a financial contract, typically with an insurance company, designed to provide a steady stream of income, often during retirement. An individual pays a sum of money, either as a lump sum or through a series of payments, to the insurance company. In return, the insurance company invests these funds and later makes regular, guaranteed payments back to the individual for a specified period or for the rest of their life. The primary goal of an annuity is to ensure a reliable income stream and protect against the risk of outliving one's savings.

While the money within an annuity grows tax-deferred, the income payments received by the individual are subject to income tax. Annuities come in various forms, offering different investment strategies and payment structures:

• Fixed Annuities: These provide a guaranteed interest rate on the money invested, offering predictable growth and income.
• Variable Annuities: The individual can choose to invest in various underlying investment options, similar to mutual funds. The income payments from a variable annuity fluctuate based on the performance of these chosen investments.
• Indexed Annuities: These offer returns linked to a specific market index, such as the S&P 500, without directly investing in the market. They often provide a minimum guaranteed return while also allowing for potential upside growth.

Annuities also differ in how long payments are made:

• Fixed-Period Annuities: Payments are guaranteed for a set number of years, regardless of how long the individual lives.
• Life Annuities: Payments continue for the entire lifetime of the individual and cease upon their death.
• Life with Period Certain Annuities: Payments are guaranteed for the individual's lifetime, but also for a minimum specified period (e.g., 10 or 20 years). If the individual dies before this minimum period ends, payments continue to a designated beneficiary for the remainder of that period.

Some annuities allow for the designation of beneficiaries, meaning that if the owner dies, the remaining payments or a lump sum may be passed directly to the beneficiary, often bypassing the probate process.

Examples of Annuities:

• Retirement Income Security: A retired teacher wants to ensure she has a predictable income stream to cover her living expenses after her pension and Social Security. She uses a portion of her retirement savings to purchase a fixed annuity from an insurance company. The annuity contract guarantees her a specific monthly payment for the rest of her life, providing her with financial security and peace of mind, knowing she won't run out of money.

  Explanation: This illustrates an annuity as a contract providing guaranteed regular payments (monthly) for life, fulfilling the core purpose of reliable retirement income. The "fixed" aspect means the payment amount is predetermined and stable, offering predictability.

• Estate Planning for Dependents: A couple in their late 60s wants to leave a guaranteed income for their adult child for a specific duration, even if they both pass away relatively soon. They purchase a fixed-period annuity for 15 years, naming their child as the beneficiary. The annuity will make annual payments for 15 years. If both parents pass away after 5 years, the child will continue to receive the payments for the remaining 10 years.

  Explanation: This example demonstrates an annuity used for estate planning, specifically a fixed-period annuity where payments are guaranteed for a set number of years. It also highlights the beneficiary feature, where payments continue to a designated person even after the original owner's death, often bypassing the probate process.

• Supplemental Retirement Growth with Income Potential: A young professional, after maximizing contributions to their 401(k), wants to invest additional savings for retirement with the potential for market growth, but also desires a future income stream. They purchase a variable annuity, allocating their funds into several investment sub-accounts offered by the insurance company. While the value of their annuity will fluctuate with the market, they anticipate converting it into a stream of income payments later in life, with the payment amounts potentially higher due to successful investment growth.

  Explanation: This shows a variable annuity, where the individual takes on some investment risk for potential higher returns. It illustrates the investment aspect of annuities and how they can be used for long-term growth before converting to an income stream, often as a supplemental retirement savings vehicle after other tax-advantaged accounts are maxed out.