An annuity is a contract between you and the insurance company that is put in place to help you in retirement or to meet long-range goals. You would pay either a lump sum or monthly payments to receive periodic payments either beginning immediately or at a later time specified in your policy. Annuities typically have tax-deferred growth of earnings. Withdrawals taken from an annuity are taxed at regular income rates, not at capital gains rates. If you withdraw your money early from an annuity, you will pay surrender charges to the insurance company as well as tax penalties.
There are three types of annuities: fixed, indexed and variable.
Fixed annuities have a fixed amount of interest that your money is guaranteed to earn for the time that your money is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. The payments may last for a determined period of time, like 20 years, or for an undetermined period of time, like your lifetime.
Indexed annuities base your return on changes in an index, such as the S & P 500 Composite Stock Price Index. They also guarantee that your contract value will be no less than a specified minimum, regardless of index performance.
In a variable annuity, you can choose to invest your purchase payments from a variety of investment options, typically mutual funds. The rate of return and the amount of payments you receive later on will be determined by the performance of the investment options you chose.