Life Annuities Information: Pure Annuity
What is a pure annuity (more correctly, a pure life annuity)?
A pure annuity is an investment account you set up with a life insurance company. You pay premiums (in installments or in a lump sum) into the account. The accumulated amount generates interests. Eventually, upon maturity, you are allowed to withdraw money (receive annuity benefits) from the account. Of course, you also pay commission or services charges to the insurance company, just like you pay a mutual fund manager commission for maintaining your account.
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If your annuity does not have the survivor benefit option, then you receive benefits from your annuity upon maturity until you die. Since it is possible that you die really early, the insurance company gives you a higher rate of return to compensate for your probability of early death.
If your annuity has the survivor benefit feature, however, your spouse or other beneficiaries will be entitled to receive benefits from your annuity even after you die. Because of this feature, the insurance company pretty much eliminates the compensation for the probability of your early death so that the rate of return is lower than the case without survivor benefits.
Now, you should understand that an annuity is almost the opposite of a life insurance. The latter pays only upon your death. For a life insurance, the older you get, the more expensive it is in terms of its premium. For a life annuity, however, the opposite is true. That is, the older you get the less expensive it becomes (or equivalently, the higher its rate of return becomes!).
Two other points about annuities that are worth mentioning are their income tax advantages and their backloading features. U.S. Internal Revenue Code allows the interest earnings generated inside an annuity account to be excluded from your current taxable income. You pay tax on the interest earnings when you withdraw money or receive benefits from your annuity. This is call "income tax deferral." The backloading feature of annuity means that you do not pay high commission to the life insurance company when you first buy an annuity from them. Instead, the company charges you a substantial amount of termination charge when you withdraw or terminate your annuity early.
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Annuities can be classified into two broad catagories according to their levels of risk, namely, fixed annuities and variable annuities.