One way to accumulate funds for retirement is to purchase an annuity. Annuities are somewhat similar to IRAs and 401(k) plans in that they allow for the accumulation and growth of funds over time and offer certain tax advantages. You can make withdrawals from an annuity at any time, although you may incur penalties for early withdrawals.
An annuity is an investment product sold by insurance companies. With an annuity, you typically agree to send the insurance ompany a specific amount of money in regular installments for a designated period of time, often until you reach retirement age. At the end of the time frame, the product "annuitizes," meaning you stop making payments and begin to receive the amount of your investment, plus any accumulated earnings. Annuities may be fixed, meaning you are guaranteed to receive a specific, predetermined return on your investment. They may also be variable, meaning the amount you receive will depend upon the performance of a separate investment account.
The minimum age at which you can begin to make withdrawals from an annuity without incurring a penalty is 59 1/2. When you begin to receive payments on or after that age, you may choose to take the money as a lump sum or select from a number of different payment options. These can range from receiving relatively large installments for a short period of time or smaller installments that last for the rest of your life. While earnings grow on a tax-deferred basis during the accumulation phase, you'll likely be required to pay taxes when you begin to receive payments.
You can also make withdrawals from an annuity prior to reaching age 59 1/2. However, because annuities are designed to be retirement-income products, the penalties for premature withdrawals are rather severe. You'll be assessed an immediate 10 percent penalty on the amount of the withdrawal and be required to pay taxes on the amount of withdrawn earnings. The insurance company may also assess its own separate surrender charges, which are fees the company levies for withdrawals made before maturity. The surrender charges are calculated as a percentage of the withdrawal amount, with the percentage generally being higher in the earlier years of the contract.
Annuity owners can make premature withdrawals without incurring the 10 percent penalty in certain situations, such as when incurring substantial unreimbursed medical expenses, divorce or disability, although any earnings received may be taxable. The annuity owner can also avoid penalization if he receives the money in what the IRS refers to as "substantially equal periodic payments," such as when an early retiree begins to receive equal monthly installments for the rest of his life, as opposed to taking a lump-sum withdrawal.
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