Tax Facts

495 / What is an “annuity”?

Strictly speaking, the term “annuity” refers to a series of payments over time in which the principal (or purchase price) and interest are amortized over the payout period, so that no value remains at the end of the annuity period; it is a stream of income. However, most people who use the term “annuity” are referring to an annuity contract, under which that stream of income is guaranteed.

There are several types of annuity contracts: (1) commercial annuities, which are contracts between a purchaser and an insurance company, (2) charitable gift annuities (see Q 607), and (3) private annuities (see Q 603). With the exception of Q 603 to Q 609, all of the discussion in this book will deal with commercial annuities.

There are many types of commercial annuities and they are very different because they are designed to do very different jobs. For this reason, any statement that begins “Annuities are….” is probably misleading or outright false, precisely because the term covers so many different types of contract.

The chart below shows the various types, in terms of when annuity payments begin.1

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