An annuity is an investment that provides an income stream for a stated period of time in exchange for a lump sum payment (single premium). The income ceases at the end of the stated period.
Types of annuity:
Annuity Certain – The stated period is a fixed duration (e.g., 10 years). Also referred to as Term Certain Annuity.
Life annuity – The income payments must be contingent on a person(s) being alive.
Under both these types of annuity, it is further categorized based on the payment pattern:
Annuity Due – The first annuity payment is due at the same time as the single premium.
Immediate Annuity – The first annuity payment falls due one payment period after the single premium is paid.
Deferred Annuity – The first annuity payment falls due after a fixed period of time. (Usually at age 65)
There are a number of standard features that could be added to the annuity contract. These include items such as a guarantee period, deferred period and escalating (index) payments.
If the income commences after more than a year from the date of the single premium, then the time between the single premium payment and the first annuity payment is called the deferred period.
Escalating annuity payments are designed to “inflation proof” the contract. The downside to escalating annuities is that they are not prescribed annuities and therefore, do not enjoy favorable taxation treatment.
If a life annuity has a stipulation that the annuity payments will be paid as long as the person is alive or at least for a specified number of years if the person dies sooner (as is the case for many pension plans), the specified numbers of years is called the guaranteed period.