What is an annuity?

An annuity can be defined as a contract which provides an income stream in return for an initial payment.

For example you buy 200K life annuity with the insurance company and insurance company based on age, health, interest rates will provide you stream of payments for rest of your life.

 

Advantages

•  Annuity can provide regualar stream of income
• Providing secure income to couples. Joint annuity and last survivour annuity will provide income until last surivivor’s death
• Annuitant does not have to worry about managing investment
• No impact of negative market performance

Disadvantage

• Income depends on the interest rate at the time of the annuity purchase
• Contract can not be changed (rarely conversion is offered but very high penalty)
• Payment can not be changed (except inflation indexed annuity)
• Income is not adjusted to inflation except for inflation protected annuities
• For life annuitiy, heirs will not get anything (Term annuity and life annuity with minimum guaranteed payments are exception)

Types of annuity:

 

1. Term-certain (or fixed-term) Annuities

This annuity guarantees monthly income for certain number of years. If the annuitant dies before the end of the term, then the remaining payments continue to go to the beneficiary stated in the contract or to the estate.

 

2. Life Annuities

Life annuities provide annuitant with a guaranteed regular income for the rest of the life. A life annuity can be purchased for a single life, or as a joint and survivor life, which is based on the lives of two people. In addition, life annuities can be purchased with or without a minimum guarantee period.