An annuity is a personal finance investment vehicle sold by insurance companies, usually to supplement your retirement planning. You make payments or premiums, which are invested, into it over time. Depending on which type of annuity you have, the premiums will grow at either a fixed or variable rate. The type of an annuity also determines what type of a premium--single or flexible--you will be contributing. Once the accumulation phase is over, your annuity starts distributing the funds back to you.
Flexible Premium Annuity
A flexible premium assumes that you will be making payments into an annuity over time, called accumulation phase. The amount and frequency of payments depends on the options your insurance company offers and your financial goals. Your money will grow (either at a fixed or variable rate, depending on the policy) tax deferred until you start taking money out (annuitization phase). At this point the payouts will be taxed at your current income tax rate.
Single Premium Annuity
With a single premium annuity, as the name implies, you make one lump-sum payment to fund your annuity account. Depending on whether this is an immediate or deferred annuity you can start taking distributions right away or after a period of time (just like with a flexible premium annuity).
An annuity can be qualified or non-qualified in terms of taxes. Premium payments to a qualified annuity, similar to a 401(k) or IRA, are tax deductible. Once the distribution phase begins, however, the payments are taxed at your normal income rate.
A non-qualified annuity does not allow tax deduction, but at distribution you will pay taxes only on the gains your funds incurred over time, since you have already paid the taxes on the premiums.
Single Premium vs. Flexible Premium
A single premium annuity might be suitable for you if you have received a large one sum payment that you would like to convert into an income stream. An immediate annuity is the best choice in case you are close to or at retirement age, because the payments start immediately.
A flexible premium annuity is a good option to invest into your retirement while you are young. The distributions at the retirement age will supplement your IRA and 401(k) income.
Writing out of Los Angeles, Tim Mammadov has been a professional writer since 2010. The majority of his articles are related to computer troubleshooting and spyware protection. Mammadov graduated from the University of Maryland, majoring in finance.