What Is a Certificate of Annuity?
A certificate of annuity is a deposit bank product that provides a fixed rate of return throughout its life. It is similar to a certificate of deposit except that the account holder must either withdraw the funds or transfer them to another annuity upon maturation. Characteristics of annuity certificates include tax-deferred interest and preservation of the original deposit amount.
Annuities are usually distinguished from lump sum payments in that they provide a string of income payments over a period of time. Financial institutions may offer a certificate of annuity as an investment option for individuals who want a guaranteed return. The interest rate or return that the annuity earns remains the same until it reaches its maturity date. It may take five, 10, 15, or 30 years after the initial deposit for the investment to mature.
With a certificate of annuity, an investor may deposit the equivalent of $100 US Dollars (USD). If the investment has a 10 year maturity date and an interest rate of 5 percent, the initial $100 USD will continue to earn a 5 percent return each year, regardless of changes in the market rate. The same concept is seen in fixed rate mortgages, where the borrower pays the exact same interest rate on his outstanding principal balance until the loan is paid in full. An annuity investment is also similar to plans that provide for future income after retirement, such as an individual retirement plan (IRA) or 401(k).
When the certificate of annuity matures, the investor must decide if he wants to withdraw the principal balance and earned interest or transfer the annuity's funds into another financial investment. If for some reason the owner of the investment decides to withdraw or cash out his funds, he must pay taxes on any interest the investment has earned. In addition, the owner may be charged a penalty fee if the withdrawal occurs before he has reached a certain age. If the funds are not withdrawn or transferred, a surrender charge may be imposed.
Investors who want to be able to count on a specific future income may find a certificate of annuity to be an appropriate financial product. Due to its fixed rate of return, individuals can calculate exactly how much they will earn within a specific amount of time. The product also provides some degree of protection in sharp market downturns. One of the disadvantages of the product is that it does not take advantage of any positive gains in the market's going interest rate.
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