The principle behind annuities is really the concept that it takes money to make money. When there is a large sum of capital available for investment, it is possible to make an even larger sum of money. An individual is faced with several problems, however, when it comes to investing large sums of available capital. The first problem is taxation. The risks involved in investing can be another problem. Most individuals do not have the knowledge necessary to reduce investment risk to a manageable level.
Insurance Companies have the expertise to wisely invest large amounts of capital and realize substantial returns. The idea behind an annuity is the transfer of the risks and responsibility of earning a return on investments from the individual to the Insurance Company. The individual, who is called the annuitant, purchases an annuity by paying a lump sum of cash to the Insurance Company. After a certain period of time, the Insurance Company begins to make regular and guaranteed payments to the annuitant. These payments can be made monthly or yearly and for various periods of time. The payments can continue for a lifetime and in some cases even beyond as the payments continue to a designated beneficiary.
An annuity is a win/win situation. The annuitant has transferred all the risk and is insured a steady and reliable income from his investment. He has also deferred his tax obligation until the time he actually receives the payments. The Insurance Company has assumed all of the risks, but has the potential to make a profit by skillfully investing the lump sum.
The amount and duration of the regular payments made by an annuity will vary according to the type of annuity. Some annuities tie the payout to a variable index such as a mutual fund. Under this very attractive annuity plan, the annuitant has the possibility of sharing in some of the investment earnings while deferring any tax liability until a later date. Some of the risk is assumed under this type of annuity, but that risk is minimized by being spread out over the term of the annuity.
One good example of the value of an annuity and how an annuity works is the large lottery winner. In most cases, a lottery winner is given a choice of taking his winnings in a single lump sum payment or as an annuity. The single lump sum payment is considerably less than the face value of the winning ticket. The total of the annuity payments, however, will equal the entire winning amount. The number of people who end up in financial difficulty shortly after receiving lump sum payments is one of the most compelling arguments for the value of annuities.
Read more annuity information at UFCAmerica.com.
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