The term “annuity” means different things to different investors. That’s because there are different types of annuities designed for different purposes. One type is the immediate fixed annuity, which can provide an immediate stream of cash payments over a lifetime or a defined period of time.
If the investor has chosen a lifetime payout option, he or she typically pays a single premium to an annuity company. In return, the company agrees to pay the investor regular and ongoing cash payments for life, or for a lesser amount to continue over the life of both spouses. Although many investors choose to receive monthly payments, it is also possible to receive quarterly, semi-annual, or annual payments as well.
Assuming the payments are structured over a lifetime, the investor is provided with a lifetime income he or she cannot outlive. Such an investment is useful for investors requiring additional retirement income, for support of a community spouse in the event the other spouse is in need of nursing-home care and is seeking to qualify for Medicaid (immediate annuities can be treated as exempt asset in some states), for making lifetime payments to cover long term care needs, or for paying long term care insurance premiums. A portion of each payment is considered a return of premium and therefore not taxable to the investor. The remainder is considered interest and will be subject to federal and state income taxes.
One drawback to these products is an early death. In such a case, the annuity company keeps the funds and the income ends. This early-death financial risk is sometimes perceived as a negative feature among some investors. However, there is a possible solution to this concern as some annuity companies will guarantee a return of the investment to heirs in the case of an early death. The feature is referred to as a “refund” provision. Other companies offer “commutation” which allows the investor to change his mind and recover his initial investment (usually with a surrender charge).
Please note, that annuities are long-term investments that are designed for retirement purposes. Annuities are also subject to administrative fees, mortality charges, and surrender charges that can apply to early withdrawals, and these fees tend to vary from company to company. Annuity premium payments and any other guarantees are subject to the claims-paying ability of the issuing company. For this reason, it is very important to consider the financial standing of the issuing company before you purchase an annuity.