Identification

• Oftentimes, investors that want a guaranteed income stream during retirement buy annuities. An annuity requires an initial deposit ranging anywhere from $5,000 to $1 million, known as the premium. This premium locks in a return of 3 percent to 10 percent. Therefore, a 10 percent annuity locks in a 10 percent return on the premium. Generally, annuities offer tax sheltering by reducing your taxable income for the current year. In addition, any earnings from the annuity grow tax-free until you begin to receive payouts.
  
  

Types

• There are two distribution models for an annuity: immediate or deferred. An immediate distribution annuity immediately begins issuing monthly payments. These payments are either fixed or variable depending on what terms you agree to. Immediate annuities are usually set up to last your whole life and are generally based on a large initial deposit from something like lottery winnings. The deferred distribution model is set up to allow an investor to contribute and accumulate money over your working life for retirement purposes. The money is able to grow tax-free during the maturity period and until you choose to take distribution of the annuity.
  
  

Features

• Annuities have several features unique to this investment medium. There is a higher guaranteed rate of return than most other comparable investment vehicles. In addition, annuities provide tax sheltering. There are no taxes paid on the money until withdrawals begin. Another popular feature of annuities is the secure principal. Generally, there is no chance that the investor's principal will be lost. This is an attractive feature to low-risk investors and those saving for retirement. Annuities offer a lifetime income option, and payments can be set up to pay out over the remainder of your life, once withdrawals begin. Finally, many annuities offer a bailout provision, which protects against interest rate fluctuations.
  
  

Advantages

• An important advantage of annuities is they are very low-risk. Money will only be lost if the insurance company goes bankrupt and your investment is more than state annuity guaranty limits. In addition, annuities are ideal for retirement income because of the guaranteed monthly retirement checks. The annuity contract locks your rate for a specified time, and solid returns with rates between 3 percent to 10 percent are common depending on maturity periods. Another unique feature of annuities is the investor is able to withdraw a limited amount of money annually without penalty.
  
  

Disadvantages

• There are a few disadvantages associated with annuities. Since annuities are structured to be long-term investments, early withdrawal penalties are significant from both the IRS and the holding insurance company. There is a 10 percent tax penalty charged by the IRS for withdrawal before the age of 59 ½. The insurance company will also charge you a penalty for any withdrawals over the allowed yearly allotment. Finally, once the money is distributed it is taxed as ordinary income not capital gains.