What are annuities?

Susan is thirty five year old professor working with a local Boston college. She lives a comfortable life with her husband Paul, who works as a firefighter with a local unit of the Boston firefighting department.

Now Paul made plans for an  early retirement. He has been battling arthritis for the past two years and is now finding it increasingly difficult to cope with the strenuous nature of his work.

When Paul shared his plans about early retirement with his seniors, they advised him to opt for an annuity.

Now many of you might question, “ What are annuities?”. Well, an annuity is nothing but a financial contract between an individual and an insurance company, wherein the insurance company promises to pay a certain sum of money to the individual in lieu of a premium or a series of premiums paid by that individual to the company.

In case of annuities, you can either pay the premium as a lump sum or in installments. Similarly, you can also decide the period for which you will be receiving your payments.

The US has some very strict laws regarding annuities. For instance, only qualified legal reserve life insurance companies can issue annuities. In addition, the federal law states that insurance companies that issue annuities should maintain a reserve, which is equal to the withdrawal amount of annuity policy issued to each individual. In addition, state laws require the insurance companies to maintain a surplus capital, as well as make a regular contribution towards the state guarantee funds.  Hence, most experts state that annuities are one of the safest instruments to invest in.

There are various types of annuities that are geared to meet the varied requirements of individuals. For instance, Jonathon, a Boston based truck driver is a risk-averse investor. Hence, when it came to choosing an annuity policy, he decided to go in for a fixed annuity. Fixed annuities provide the investor with a fixed amount of money for a pre-decided period of time. Since the rate of interest is fixed, the investor is protected against market fluctuations.

However, Jonathon’s brother Jack chose to go in for an equity linked fixed annuity. Jack works as a researcher with a Boston based pharmaceutical company. Since he is young, he decided to become a little more adventurous with his investments. In case of an equity-linked fixed annuity, the annuitant receives a minimum guaranteed amount of return. The rest of the returns are based upon the performance of stocks and the stock market in general. Equity indexed annuities invest in equity indices like Standard & Poor's 500 Composite Stock Price Index, Dow Jones Industrial Average, NASDAQ 100, and Russell 2000. Gains made from the stock market are added to the annuity policy. Hence, an equity-linked fixed annuity allows the annuitant to benefit from a booming stock market while protecting him from losses by giving out guaranteed payments.

Sometimes investors prefer to receive an income for their entire life. Take the case of Jessica. She is a pure vegetarian and a devout Yoga follower, who runs Yoga classes in Boston. Jessica fears that she might outlive her savings. Hence, she is looking for an annuity that can guarantee her with a lifetime income. Investors like Jessica  should opt for life annuities. In case of life annuities, the insurance company promises to provide the annuitant with an income for his entire lifetime. If you opt for a joint life annuity, your partner will become eligible to receive the income in case of your death.

We all are aware of the fact that the payment in case of annuities is receivable only after the lapse of a certain period of time. But there are certain types of annuities, which start making payment immediately after receiving the premium amount from the investor. They are termed as immediate annuities. Our Boston based firefighter should preferably opt for an immediate annuity, as he wants to retire in a few years time.

However, if you want your annuity to pay handsomely, then you need to invest in variable annuities. Variable annuities invest in stocks and bonds. Hence, their returns tend to fluctuate violently. However, if your investment period coincides with a boom period, then you can look forward to receiving good earnings from your annuity.

Annuities are thus the perfect way of creating a retirement nest egg.

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