An annuity is another way to set aside retirement savings on a tax-deferred basis. Unlike IRAs and Keoghs, an annuity is the actual investment product.
An annuity is a contract you enter into with an insurance company. For a fixed sum of money, the insurance company promises to pay you income starting today (immediate annuity), or income sometime in the future (deferred annuity).
Deferred annuities are used for retirement planning. You typically make one or more premium deposits, and the insurance company invests your premiums. You don't pay any tax on the internal buildup of the annuity's value until you begin taking distributions, usually during retirement. A number of payout options are available; the most common offers fixed payments for life.
IMPORTANT NOTE: Annuities are long-term investments. If you begin distributions before age 59½, you may be subject to a 10% penalty on the portion of the withdrawal that represents accumulated earnings. In addition, the earnings are subject to ordinary income tax. Finally, the annuity may impose surrender charges on withdrawals that exceed a certain amount during the early years of the contract) (see the section Understanding the Fees).
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