Annuity is a financial investment instrument/tool that is designed as a reliable means of securing a steady income stream for life. This financial product is somewhere between insurance and investment and is largely marketed as a nontraditional way to generate income during retirement.
Annuities can be structured in different ways, depending on several factors. Annuities that are created to turn a large sum into steady cash flow can be structured to pay out funds for a fixed amount of time, either immediately or as deferred benefits.
Example: winning the lottery and setting up annuity so that the money is gradually paid out, like a salary or a pension. Alternatively, setting up annuity of a large cash settlement to be paid out over a set period of time (10-20 years) instead of all at once.
The various types of annuities typically fall into two categories: fixed and variable.
Fixed annuities work much like a certificate of deposit, but generally have a higher interest rate. The payments from a fixed annuity are for life and they are stable and secure. However, the returns are capped at a fixed rate and not adjusted for inflation over time.
Variable annuities allow for the money deposited to be invested in stocks, bonds and/or market funds. If the investments made by the annuity fund do well, the annuity owner’s future returns can be greater. However, if the investments underperform, the annuity returns will be lower. Through the payout is potentially higher, the cash flow of a variable annuity is less stable than a fixed annuity and carries a higher risk.
It is generally advised to carefully read all terms and conditions about fees, charges and expenses, before deciding on investing in either type of annuity.
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