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Personal Financial Planning
Notes This unit focuses on various sources of income in retirement planning and how an individual
can accumulate enough wealth so as to lead a happy retirement life. It will deal with various
types of investment options available for retirement planning. You will also learn about the
concept of mortgages and their types in the later part of the unit.
10.1 Annuities and its Types
Most investors share the same goal of long-term wealth accumulation. Some of us have no
problem watching our investments bounce up and down from day to day, while risk-averse
investors or those nearing retirement generally can’t withstand short-term volatility within
their portfolios. If you are this type of investor – or one who has a moderate risk tolerance –
annuities can be a valuable investment tool.
10.1.1 Meaning of Annuity
An annuity is a contract between you – the annuitant – and an insurance company, who promises
to pay you a certain amount of money, on a periodic basis, for a specified period. The annuity
provides a kind of retirement-income insurance: you contribute funds to the annuity in exchange
for the guaranteed income stream of your choosing later in life. Typically, annuities are purchased
by investors who wish to guarantee themselves a minimum income stream during their
retirement years.
10.1.2 Benefits of Annuity
Most annuities offer tax sheltering, meaning your contributions reduce your taxable earnings
for the current year, and your investment earnings grow tax-free until you begin to draw an
income from them. This feature can be very attractive to young investors, who can contribute to
a deferred annuity for many years and take advantage of tax-free compounding in their
investments.
Because they are a long-term, retirement planning instrument, most annuities have provisions
that penalize investors if they withdraw funds before accumulating for a minimum number of
years. Also, tax rules generally encourage investors to prolong withdrawing annuity funds
until a minimum age. However, most annuities have provisions that allow about 10-15% of the
account to be withdrawn for emergency purposes without penalty.
10.1.3 Annuity Consideration
The money that an individual pays to an insurance company in exchange for a financial
instrument that provides a stream of payments for a given length of time. An annuity consideration
may be made as a lump sum or a as a series of gradual payments. It is also referred to as a
“premium”.
10.1.4 Types of Annuities
Generally speaking, there are two primary ways annuities are constructed and used by investors:
immediate annuities and deferred annuities.
With an immediate annuity, you contribute a lump sum to the annuity account and immediately
begin receiving regular payments, which can be a specified, fixed amount or variable depending
upon your choice of annuity package and usually last for the rest of your life. Typically, you
would choose this type of annuity if you have experienced a one-time payment of a large
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