What is an Annuity?

Annuities are financial vehicles used for creating a predictable and secure stream of income. An annuity is a contract between you and an insurance company, where you give the insurance company a lump sum of money, either as a single payment or as a series of payments, and in return the insurance company pays you as regular income over a certain amount of time. You can set up an annuity to last for your entire life, called an immediate annuity, or you can set up an annuity to last for a predetermined number of years, known as a Deferred Annuity.

Types of Annuities

There are four basic types of annuities: fixed, index-linked, variable, and immediate.

Fixed annuities are the simplest type of annuity and guarantee a fixed return rate. The insurance company guarantees that your annuity payment will not fluctuate based on the performance of the market or the stock index.

Index-linked annuities link the performance of your annuity to the performance of an external index, such as the S&P 500. In a rising market, your annuity payments can increase, but if the index declines, you may not receive any additional payments.

Variable annuities allow you to choose a portfolio of investments to fund your annuity. The performance of your investments determine your annuity payments.

Immediate annuities are the most common type of annuity and provide you with a fixed income stream for the remainder of your life.

Advantages of Annuities

Annuities provide a secure source of income, which can help to supplement other sources of retirement income such as Social Security, pensions, and investment income. Annuities are also exempt from taxes until you start taking withdrawals, which allows you to save more money over time. Finally, annuities can help you pass on an inheritance to your heirs, as you can opt to have the funds go to them after you pass away.

Disadvantages of Annuities

One of the primary drawbacks of annuities is their lack of liquidity. Once you invest in an annuity, you are stuck with it until the contract ends, which may not be ideal if your goals and needs change over time. Annuities also generally have high surrender charges, which is the amount you pay if you decide to cash out or terminate your annuity before the end of the contract term.

Conclusion

Annuities are a great way to create a steady stream of income during retirement, but like any financial product, they have risks and disadvantages. Make sure to understand all the terms of your annuity before making any commitments and speak with a certified financial advisor for additional advice.