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Simple English definitions for legal terms
annuity
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A quick definition of annuity:
An annuity is a long-term agreement between an individual and an insurance company. The individual pays money to the insurance company, which invests it and guarantees to make regular payments to the individual for a set period of time. Annuities are often used for retirement planning to ensure a steady income during retirement. There are different types of annuities, including fixed, variable, and indexed, each with its own benefits and risks. Annuities are subject to income tax, and it is recommended to contribute to pre-tax retirement accounts before buying an annuity. Annuities can also be non-probate assets that pass to designated beneficiaries at death.
A more thorough explanation:
An annuity is a long-term contract between an individual and an insurance company. It is usually used as part of retirement planning. The individual pays money to the insurance company, which invests it. The insurance company then pays the individual regular amounts of money for an agreed period of time. This guarantees income during retirement and removes the risk of running out of money. However, the payments are subject to income tax.
There are different types of annuities:
- Fixed annuities: guarantee a fixed rate of interest for a specific period of time.
- Variable annuities: allow individuals to invest in various securities, with the payments dependent on the success of the investments.
- Indexed annuities: combine the benefits of fixed and variable annuities because the returns are based on the performance of a stock market index.
There are also different terms of annuities:
- Fixed-period annuities: guarantee payments for a set length of time.
- Life annuities: end at the death of the owner.
- Life with period certain annuities: guarantee payment for the owner's life but also allow them to choose a fixed period of guaranteed payment.
John wants to make sure he has enough money for retirement. He decides to buy a fixed annuity from an insurance company. He pays $100,000 to the insurance company, which guarantees him a fixed rate of interest for 10 years. After 10 years, the insurance company will start paying John a fixed amount of money every month for the rest of his life. This guarantees John income during his retirement years and removes the risk of running out of money.
Another example is Mary, who wants to invest in the stock market but also wants a guaranteed income during her retirement years. She decides to buy an indexed annuity from an insurance company. The returns on her annuity are based on the performance of the S&P 500. If the stock market does well, Mary will receive a higher payment. If the stock market does poorly, Mary will still receive a guaranteed minimum payment. This allows Mary to invest in the stock market while also having a guaranteed income during her retirement years.
These examples illustrate how annuities work and how they can be used as part of retirement planning. Annuities provide a guaranteed income during retirement and remove the risk of running out of money. However, they are subject to income tax and there are different types and terms of annuities to consider.