How Do Annuities Work?
The term annuity basically refers to an arrangement that is made between two parties. One of these parties is generally an individual, who gives a sum of money, called the premium, in regular payments or a lump sum, to the second party, which is often an insurance company. In return, the second party gives a steady stream of payment to the first party over a stated period of time that is stated in the arrangement.
Annuities be make up of consistently long term products and are a very straight forward approach to funding your future. However, before purchasing, its important for you to have a good understanding of what youre buying.
There are two major kinds of annuity agreements. The first, called annuity certain, specifies the certain period for payment. For example, suppose you pay a certain amount of money to an insurance company for a twenty year annuity. You make an agreement whereby monthly payments are sent out along with a percentage growth, over the period of annuity. You will be a paid a stated amount of money, every month, till the arrangement comes to end.
The second kind, called the life annuity, is most commonly employed by people who have retirement savings in mind. In this agreement, you pay a lump sum to the insurance company and they pay the money back to you at a stated amount every year for the rest of your life. Life annuities, when done in conjunction with a charity or a nonprofit organization, can offer additional tax benefits.
Among the many things you need to know about investing in an annuity is that it has mainly two types of balances that are running simultaneously. The first balance is your account value, also known as the contract value. This refers to the amount of money obtainable to you at any given example of time. It depends largely on the performance of the investments within the annuity that are also known as sub accounts.
The second one is the assistance base or the income base which is considered more as a hypothetical account. It is used to represent the amount of money that determines the annual guaranteed income one can draw from the annuity.
It is important to be aware of the differences between these two as sometimes you will come across variable annuities surrounding a guaranteed return that apply only to the income base and not to the actual account value. Income value is not the amount you can cash out. The only balance that you can withdraw when needed is your account value which may or may not be higher than your income base.
now and then the insurance company will compare your account value with the income base. This, in most situations, is done on the anniversary date of the contract. If your account value turns out to be greater than your income base, then the insurance company will increase the assistance base such that it will be equal to the account value.