A private annuity is a promise by an individual, such as a child, to pay a fixed amount of money to someone every year for the rest of your life. You buy this annuity by paying money, or selling an asset, to the person who has promised to make the payments to you. (This kind of annuity should compared with a commercial annuity, which is payable by an insurance company, or with a charitable gift annuity, which is payable by a charity.) The amount of the payment is based on IRS tables, which take into account IRS life expectancy tables and an IRS determined interest rate, as well as the amount you paid for the annuity promise. The promise must be unsecured, so you are relying on the creditworthiness of the person making the promise. The payments you
receive are partially ordinary income, with the balance either a tax-free return of your investment (basis) or capital gain. The person making the payments will invest the money you've transferred to him or her (so generally that means the person will be paying income tax on the income), but doesn't get a deduction for the payments made to you. Thus, effectively, the income earned on the money you've transferred is taxed twice (once to the person making the payments and again to you.) Generally, a private annuity makes financial sense only if you die within a few years after buying the annuity; but on the other hand, if you are suffering from an illness expected to kill you within a year (or in some cases, two years), the IRS tables can't be used but rather your actual life expectancy must be used to set the amount of the payments. Generally, it doesn’t make sense to fund a private annuity with appreciated assets.