There are two types of annuities: immediate and deferred. The main difference between them is when the distribution phase begins - in other words, one annuity stars paying you right away, while the other won't begin paying out until later. Both types let you contribute as much as you like to your account, and both of them will provide a guaranteed paycheck for life once you begin taking those distributions. Let's look a little closer at each type.
Immediate annuities work best if you have a lump sum of cash you want to convert into an income stream. The entire annuity is funded with one lump-sum payment instead of with a series of monthly payments, the way you'd fund a deferred annuity. When you buy an immediate annuity, you'll also need to start receiving payments within 12 months of your purchase.
Immediate annuities appeal to retirees and near-retirees who want an investment return they can't outlive. The distributions are considered partly a return of the original investment and partly earnings. You are taxed on the earnings portion only. Your accountant can help you figure out the split, and how annuity payments will affect your overall tax liability.
You can buy a deferred annuity with either a lump sum or a series of monthly payments. Unlike an immediate annuity, the point of a deferred annuity is to pay into it over time and put off the payout until your retirement. While you're paying into the annuity, that period of time is called the "accumulation period." The earnings in your annuity are not subject to taxation until distributed.
Deferred annuities are a great option as an investment supplement to IRAs and qualified pension plans such as 401(k) plans. Many investors use deferred annuities to offset the risk in their stock portfolio. You can fund them over time while you work, and when you retire, you can start accepting payments that will continue until you pass away. Many clients appreciate the security of an annuity, especially as a way to offset any potential losses they incur in the stock market.