What is an Annuity?
An annuity is a contract between an individual ("annuitant") and an insurance company. The annuitant agrees to pay the insurance company a single payment or a series of payments. The insurance company agrees to pay the annuitant an income, starting immediately or at a later date, for a specified time period. Under current tax law, money put into an annuity grows on a tax-deferred basis until the annuitant begins receiving his accumulated fund as an income. This means that one hundred percent of your earnings are reinvested in an annuity and allowed to compound-- or grows -- without having to pay taxes on earnings.
Long considered a CD alternative, annuities have become very popular today. Paying higher rates than CDs and deferring taxes, many people on a fixed income find annuities are a better option than tying up money in CDs or letting it sit in a money market account. Like a CD, you can place lump sums of money in annuities. You must leave the money in the annuity for a period of years, usually between two and five years. The longer you leave the money in, the higher your interest rate will be. Depending on the annuity purchased, a yearly amount is allowed to be withdrawn without a penalty. This amount is usually around 10%.