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What is an annuity? Are there different kinds of annuities?

An annuity is a financial contract between two parties (the issuer and the annuitant) where the annuity issuer agrees for a stipulated premium deposit to pay to the annuitant regular payments at regular intervals. The payments to the annuitant start on a specified date and are guaranteed for a fixed period or for life, or both. There are two basic types of annuities available:

Immediate Annuities: where the annuities bought with a single lump-sum payment. Annuity income starts one month later (if it is to be paid monthly) or one year later (if it is to be paid annually); Deferred Annuities: where, for example, an annual premium is paid during the holder’s working years until a certain date in the future (usually retirement) called the “maturity date”, at which time payments cease and benefits start. Immediate annuities include two types -- straight life annuities and life annuities with a guaranteed payout period. A straight life annuity pays the purchaser a guaranteed monthly or annual income until he or she dies. Life annuities provide the highest amount of guaranteed income per dollar of premium paid because when the annuitant dies, the payout stops and no residual payment is made to the annuitant’s estate or beneficiaries. Straight life annuity payments are a combination of capital and income, which establishes a guaranteed lifetime cash flow for an annuitant. The main advantage of a straight life annuity is the fact that an annuitant cannot outlive his or her capital. A straight life annuity is also suitable for a person who had dependants who are fully provided for by other means and is concerned with obtaining a highest available guaranteed income from the straight life annuity. Life annuities with a guaranteed payout period provide for a guaranteed number of payments to beneficiaries. For example, if a purchaser of a life annuity with a 10-year guaranteed term dies after two years, his or her beneficiaries would continue to receive the same payments for another eight years. As well as the type of life annuity selected and the annuitant’s state of health, the following factors are also taken into consideration when determining the amount of income to be guaranteed by the annuity issuer: Deferred annuities permit the deferral of payments for up to several years (not later than January of the year the annuitant reaches age 70 for annuities purchased with registered funds). They are usually set up to start anywhere from a few months to up to ten years from the date of purchase. A deferred annuity can be for life or for a fixed term with payments on a fixed or variable basis. With a guaranteed annuity, the annuity issuer guarantees exactly how much monthly income will be paid out later for premiums paid in over the life of the deferred annuity. The size of the premium paid for the deferred annuity depends on factors such as how soon the annuitant wishes to receive income payments and how much income is desired. Often the deferred annuity issuer will allow the holder to arrange to pay different amounts each year if this is preferable. Unlike RRSPs, contributions to a deferred annuity are not tax-deductible. Deferred annuities provide an opportunity to defer the tax payable on investment income until a later time.