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What Are Annuities?

An annuity is a contract between you and an insurance company in which you make a lump-sum payment or series of payments and, in return, receive regular disbursements, beginning either immediately or at a certain time in the future.

The specific goal of an annuity is to provide a steady stream of income, typically during the era of retirement.

The income you receive from an annuity is taxed at regular income tax rates, not long-term capital gains rates, which are usually lower.

What Else Should I Know About Annuities?

As stated above, annuities come in three main varieties: fixed, variable, and indexed. Each type has its own level of risk and payout potential. 

Fixed annuities pay out a guaranteed amount. The downside of this predictability is a relatively modest annual return.

Variable annuities provide an opportunity for a potentially higher return, paired with greater risk. In this case, you pick from a menu of mutual funds that go into your personal “sub-account.” Here, your payments in retirement are based on the performance of investments in your sub-account.

Indexed annuities fall somewhere in between when it comes to risk and potential reward. You receive a guaranteed minimum payout, although a portion of your return is tied to the performance of market index. 

Variable and indexed annuities are often criticized for their complexity and high fees in comparison with other kinds of investments.

Tax Treatment – Annuity

A very important factor to consider with any annuity is its tax treatment. While your balance grows tax-free, the disbursements you receive are subject to income tax Additionally, unlike a traditional 401(k) account, the money you contribute to an annuity doesn’t reduce your taxable income.

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