Although they do not fit within the strict definition of insurance, annuity policies are now widely viewed as a form of insurance. However, the insurance aspect of an annuity basically goes to the fact that the annuitant will receive a guaranteed income payment (usually for the rest of his or her life). Annuities were not regarded as insurance at common law, but commercially issued annuity policies are now largely regulated by state insurance statutes. Some types of annuities such as variable annuities are securities that are regulated by the Securities Exchange Commission. Fixed annuities are not securities and are not regulated as such.

Generally, an annuity is a contract in which the buyer deposits money with the seller for investment. In exchange, the seller agrees to make lump sum or periodic payments to the annuitant(s) for a fixed term or life. An annuity differs from a life insurance policy in that the annuitant is generally protected during his or her lifetime by virtue of guaranteed income. Conversely, a life insurance policy protects designated beneficiaries in the event of the policyholder's untimely or premature death. Life insurance pays when the insured dies while the annuitant receives income payments during his or her lifetime.

Generally, annuity benefits are calculated in much the same way as life insurance premiums and benefits are calculated. Actuarial tables and assumed life expectancies are utilized, and interest is compounded based on these figures and projections. Thus, the amount of the annuity benefit will depend on a number of factors including the annuitant's age at the time the policy was purchased, when the benefit payments commence, and the applicable compound interest rate.

Deferred annuities can offer tax advantages because income taxes will not be due and owing until money is withdrawn. Retirees find this an attractive feature when they anticipate that they will be in a lower income tax bracket during retirement. One drawback is that the Internal Revenue Service will impose a 10 percent early withdrawal penalty in addition to a tax on ordinary income if income is drawn before the annuitant reaches the age of 59 and one-half years. The insurer or company that administers the annuity may also impose a hefty early withdrawal penalty. Thus, deferred annuities should always be viewed as long-term investment vehicles. Generally, no income tax reporting is required for deferred annuities unless a withdrawal is made. When the annuitant dies, the value of the contract is included in his or her estate. Any gains are taxable to the beneficiary (except the surviving spouse).

An advantage of a fixed annuity is that there is a guaranteed minimum interest rate. The issuer typically backs the value of the annuity, and a state insurance guarantee fund may secondarily cover the fixed annuity.

It is also important to note that the issuer of an annuity generally does not have a fiduciary relationship with the buyer or annuitant. The relationship between the issuer and the buyer/annuitant is more of a debtor-creditor relationship. Even so, special duties and liabilities may arise depending upon the circumstances of the transaction, the buyer/annuitant's circumstances, the parties' actions, and even the issuer's or agent's sales practices.

The buyer is the owner or contract holder of the annuity. When the policy matures and payments begin, the person who receives the annuity income is referred to as an "annuitant." The buyer and the annuitant are often the same person. There may be more than one annuitant, depending on the annuity contract.

Copyright 2010 LexisNexis, a division of Reed Elsevier Inc.