What Is an Annuity?

​​Q:  What is an annuity?
A:  An annuity is an investment held by an insurance company that allows the insurance company to put your money in various investments, including stocks and bonds. The annuity then:
•  pays you back with a series of payments over time; or
•  pays you back when you draw the money out; or
•  pays out to designated beneficiaries (those you have named to receive the money) upon your death.

Q:  How do the different types of annuities work?
A:  An immediate annuity pays you a fixed amount on a regular basis over a period of time or for life. For example, you might buy an immediate annuity that pays you $100 per month for ten years. Or, you might buy an annuity that pays you $3,000 per year for the rest of your life.

A deferred annuity accumulates interest and dividends until you choose to withdraw the money. If the deferred annuity is still in place at your death, all of the income will be paid to your beneficiary and taxed.  

An annuity can be “fixed,” meaning it has a set rate of interest at the time you buy it. Or, it can be “variable,” meaning your return varies based on the success of the investments made by the insurance company.

Q:  Will my money be secure if I invest in an annuity?
A:  Annuities are investments. When you buy an annuity, your contract with the insurance company is tied directly to investment results. The financial strength of the insurance company is very important. If the insurance company has or develops financial problems, you may lose at least some money. Annuities are not insured by the FDIC. However, a certain portion of your money is guaranteed by the Ohio Guaranteed Insurance Fund.

Q:  Do I have to pay taxes on my annuity?
A:  Yes. If you earn money on an annuity, you must pay regular income taxes at ordinary income rates on the amount of your gain (though not on your original investment), but only when you receive the income. Some people choose to buy deferred annuities so they can defer income and wait to pay taxes at a later date, when they expect their income tax rates will be lower.

Depending on the size of your estate when you die, your estate also may have to pay state and federal estate taxes on your deferred annuity, and your beneficiaries may have to pay income tax.

Q:  Can I get my money out of an annuity if I need it?
A:  If you have an immediate annuity, your money is locked in a fixed payment schedule. You may not get your money back faster if you need to, or it will come in at a reduced or commuted value. If you have a deferred annuity, you can remove your money when you need it, but you may have to pay a penalty or “surrender charge” to take your money out early. However, many deferred annuities let you withdraw ten percent of your principal each year without penalty. Some will also waive penalties in certain circumstances such as to pay for nursing home care.

Q:  Do annuities offer higher returns than other investments?
A:  An annuity’s interest rate may be higher than that of a bank CD, but this rate may not be guaranteed or may only be guaranteed for a limited period of time. On variable annuities, there also may be management costs and fees that may lower the effective rate of return.

Q:  Does the annuity salesperson receive a commission?
A:  Yes. Although you will not see the amount as a direct payment, the insurance company that issues the annuity pays the insurance agent an upfront commission of three to eight percent of the price of the annuity. The insurance company covers the cost of commissions by reducing your return on the annuity or increasing the surrender penalty. ​Normally, the greater the commission, the greater the surrender charges.

Q:  How can I decide if an annuity a good investment for me?
A:  If you are in a high tax bracket, have years for this money to grow, and expect to be in a lower tax bracket when you withdraw the money, a deferred annuity may make sense.  

If you want an assured monthly income and are willing to pay a lump sum of money to receive it, an immediate annuity from a reputable company may be wise.

If you are already in a low tax bracket and you think you may need quick access to your money, an annuity may not be a good idea.


This "Law You Can Use"consumer legal information column was provided by the Ohio State Bar Association (OSBA). It was prepared by Munroe Falls attorney Marta J. Williger.

Articles appearing in this column are intended to provide broad, general information about the law. This article is not intended to be legal advice. Before applying this information to a specific legal problem, readers are urged to seek advice from a licensed attorney.



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