Annuities are financial contracts with insurance companies that can help people save money for retirement. Funds that are deposited into an annuity grow, tax-deferred, until they are withdrawn, generally after the person reaches retirement age. A fund that pays income to one insured person during retirement is called a single life annuity. The insured person is known as the annuitant.
Single life annuities are available with various payout options. In a straight life annuity, payments end with the annuitant's death. Annuity buyers can also purchase a refund option. With this, any money remaining in the straight life annuity after the annuitant dies will be forwarded to the beneficiary named in the contract.
A guaranteed period, or term, can also be added to a single life annuity. A guaranteed term ensures that payments will be made for a certain number of years, even if the annuitant dies before the end of the term. In this case, payments will be made to the annuitant's estate or beneficiary until the guaranteed period ends.
Interest earned with annuity funds is tax-deferred until the interest is withdrawn. In the United States, annuitants must be age 59 1/2 or older to avoid paying a penalty tax on funds withdrawn from a single life annuity. This penalty tax is in addition to the income tax due on the withdrawal.
Most often, an annuity is either a deferred or immediate annuity. A deferred single life annuity has two phases known as accumulation and payout. Funds are deposited into the annuity and earn interest for several years during accumulation phase. During the payout period, the annuitant gets payments that include the principle and accumulated interest. The accumulated interest portion of the payouts is taxed at the annuitant's current tax rate.
Single life annuity holders who purchase immediate annuities usually start receiving payments within the first year of the annuity contract. The remaining balance continues to earn tax-deferred interest. Similar to deferred annuities, income tax on earned interest is due when it is withdrawn from the annuity.
Married couples may consider joint and survivor annuities instead of single life annuities. A joint annuity provides retirement income payments to both spouses. Upon the death of the first annuitant, the surviving spouse inherits the remaining value of the annuity. Payments will continue to be made to the surviving spouse for the term specified in the joint annuity contract.
Sometimes, income from an annuity is not needed during retirement years. In this case, couples can also consider using annuity funds to purchase a joint life insurance policy. Annuity withdrawals used to purchase a life insurance policy are generally subject to income and penalty tax, if applicable.