What Is An Annuity? Here Is Everything You Need To Know

When it comes to income in retirement, most people think of Social Security and taking money from any retirement accounts they have.

But there is another option.

An annuity.

Annuities are a vehicle you can use to not only provide an income, but also protect the money you worked so hard for.

And you can take advantage of annuities even before your ever retire.

Truth be told, there is a lot to annuities and the more you understand how they work, the greater the chance you will end up with the one that fits your needs perfectly.

So in this post, I am going to walk you through annuities so you have a solid grasp of how they work and get an idea of which one might make sense for you.

What Is An Annuity? Your Complete Guide

Annuity Definition

what-is-an-annuity

Insurance companies sell annuities for savings protection and for their clients’ future income needs.

Basically, an annuity is an insurance contract that provides you with regular payments immediately or at some point in the future.

You can purchase an annuity to protect your income, grow your savings for retirement, or to provide you with a guaranteed income for life.

Types Of Annuities

The issue a lot of people find when looking into annuities are the various types.

Annuities are offered as:

  • Fixed annuities
  • Variable annuities
  • Fixed-indexed annuities
  • Immediate annuities
  • Deferred annuities

Each one works a little different from the next and each offers different advantages.

Picking The Annuity For You

What you choose in an annuity product depends on:

  • The risk you can comfortably assume
  • Your income and earnings goals
  • When you want to receive your annuity income

What you select in an annuity then depends on your current living situation.

For instance, you will receive a higher income with an immediate annuity but must sacrifice the principal.

On the other hand, a variable annuity increases your principal, but you will also pay higher fees.

Features Of The 5 Annuity Types

#1. Fixed Annuity

A fixed annuity represents a fixed interest investment issued by an insurance company.

You receive a guaranteed interest rate, typically higher than a bank CD.

A great benefit is the option to defer the income or draw it out immediately.

Pre-retirees or retired persons prefer fixed annuities, as they offer a modest and no-cost fixed investment that is guaranteed.

You won’t risk your income or death benefits, and the investment provides a predictable income regardless of the stock market’s performance.

You also receive a lifetime income that you or your spouse won’t outlive.

#2. Variable Annuity

This type of annuity allows an investor to choose from various sub-accounts, which are mutual funds.

Therefore, the account value is decided on the performance of the mutual funds.

You can purchase a rider to lock in the income stream, regardless of market performance.

This provides a hedge should the markets perform poorly.

If you are a retiree or pre-retiree who wants a guaranteed lifetime income with some capital appreciation thrown in for good measure, this annuity might be a good pick.

#3. Fixed Index Annuity

This type of annuity is fixed and features a variable interest rate, included in the contract value if the underlying market index is positive.

The annuity offers a guaranteed minimum income and a chance of an increase in principal, based on the market index.

However, the upside potential for the principal is restricted by caps, spread, or the participation rate, all which trim the returns if the stock market rises.

However, you don’t have to worry about upfront fees when choosing the annuity.

You can benefit from stock market gains and also receive investment protection when the market is down.

#4. Immediate Annuity

An immediate annuity mirrors a life insurance policy.

Instead of receiving a lump sum payment after paying into an insurance policy, you give the insurer a lump sum payment to receive regular payments for a specific period or until your death.

The payouts begin one to 12 months after the receipt of the investment. 

Payments are usually higher than other annuities, as they include principal and interest, and a favorable tax treatment.

If it is okay with you to sacrifice principal for a higher lifetime income, this annuity may be attractive.

Single payment immediate payment annuities (SPIAs) allow you to make one lump sum payment, and no further payments after the one transaction.

#5. Deferred Annuity

A deferred annuity defers your payments to a future date, typically over a year.

A deferred annuity appeals to people who wish to receive an income at a future date or wish to create an income ladder later.

For instance, you may want to work during retirement, but wish to have a guaranteed income after you stop working.

Buying Annuities Online

When it comes to buying an annuity, you typically go through a licensed insurance agent.

However, thanks to technology, you are now able to buy annuities online.

You will achieve the greatest benefit by buying annuities online, as you can review each prospectus and find out which annuity works best for your lifestyle and income stream.

If you have questions, you can reach out to the company selling the annuity and ask.

At the end of the day, it is up to you and how you feel most comfortable when it comes to purchase your annuity.

Choosing How You Will Be Paid

annuity payments

Annuity payouts can be arranged in one of various ways.

Here are the most common.

#1. Life-Only Payments

Life-only payouts give you a regular guaranteed income from your annuity for life.

Therefore, the income will not run out before you die.

#2. Joint And Survivor Payouts

Joint and survivor payouts allow your spouse to still receive payments after your death.

Payments are determined by the life expectancies of the couple.

Therefore, the payments are usually lower.

#3. Fixed Period Payments

A fixed period option allows you to choose a specific payout period.

Because payments stop at a certain point, they usually are higher.

However, you still run the risk that the payouts will run out before you die.

#4. Life with Period Certain Withdrawals

Life with period certain or guaranteed payments allow you to receive guaranteed payments for life.

You also have the option to select a time your annuity will pay your designated payee if you pass away before your guaranteed payout ends.

#5. Fixed Amount Payments (Regular Withdrawals)

A systematic withdrawal or fixed amount payout schedule gives you the ability to choose the payment amount you wish to receive monthly.

Payments continue until the accumulated value of the annuity is paid.

Therefore, the payments depend on the amount of the annuity and the payment amount you select.

In this instance, you could easily outlive our payments.

#6. One Lump Sum Payout

A lump sum payment allows you to receive your annuity payment as one lump sum.

However, if you choose this distribution, you have to pay taxes on the total investment gain for the annuity. 

Payments are usually received by ACH bank transfer however some companies will still mail you a paper check.

Final Thoughts

At the end of the day, annuities can be confusing to many people because of the various types of annuities and the different ways you can be paid out.

The most critical thing to remember with annuities is to not rush into anything.

Take your time to fully understand the type you are considering and if it meets all your needs.

If you do this, you will increase the likelihood of matching the right product with your needs and will be happy in the long run.

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