Annuities

Annuities are insurance contracts that provide a fixed income stream for a person’s lifetime or a
specified period of time. An annuity can be purchased with a lump sum or a series of payments
and begin paying out almost immediately or at some point in the future. Annuities are often used
as a way to fund retirement.
ON THIS PAGE

 What Is an Annuity?
 How Do Annuities Work?
 Immediate or Deferred
 Annuity Types
 Is an Annuity Right for Me?
 Benefits
 Disadvantages
 Getting Started
 FAQ

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Annuities can be optimized for income or long-term growth, but they are not short-term
investment strategies. These products appeal to people whose objectives include long-
term financial security, retirement income, diversification and principal preservation.

Key Takeaways

 An annuity is a customizable contract issued by an insurance company that

converts an investor’s premiums into a guaranteed fixed income stream.
 The type of annuity you purchase determines your future annuity payments.
 The primary benefits of buying an annuity include principal protection, the
potential for guaranteed lifetime income and the option to leave money to your
beneficiaries. Some annuities may also be optimized to help pay for long-term
care.

What Is an Annuity?
An annuity is an insurance product designed to provide consumers with guaranteed
income for life.

More specifically, an annuity contract is a legally binding, written agreement between

you and the insurance company that issues the contract. This contract transfers your

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longevity risk — the risk of you outliving your savings — to the insurance company. In
exchange, you pay premiums as outlined in the contract.

How Do Annuities Work?

Annuities work by converting a lump-sum premium into a stream of income that a
person can’t outlive. Many retirees need more than Social Security and investment
savings to provide for their daily needs.

Annuities are designed to supply this income through a process of accumulation and
annuitization or, in the case of immediate annuities, lifetime payments guaranteed by the
insurance company that begin within a month of purchase — no accumulation phase
necessary.

In essence, when you buy a deferred annuity, you pay a premium to the insurance
company. That initial investment will grow tax-deferred throughout the accumulation
phase, typically anywhere from ten to 30 years, based on the terms of your contract.
Once the annuitization, or distribution, phase begins — again, based on the terms of
your contract — you will start receiving regular payments.

Annuity contracts transfer all the risk of a down market to the insurance company. This
means you, the annuity owner, are protected from market risk and longevity risk, that is,
the risk of outliving your money.

To offset this risk, insurance companies charge fees for investment management,
contract riders, and other administrative services. In addition, most annuity contracts
include surrender periods during which the contract holder cannot withdraw money
from the annuity without incurring a surrender charge.

Furthermore, insurance companies generally impose caps, spreads and participation

rates on indexed annuities, each of which can reduce your return.
Annuities Explained

Free-Look Period
Most states require insurance companies to include a free-look period that allows
a buyer to cancel the contract without incurring a surrender charge.
Riders
Riders are addendums that allow the customization of basic annuity contracts. It’s
important that you understand the riders you select and are aware of their
additional costs.
Beneficiaries

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 You can add a death benefit rider to your contract to ensure that your beneficiary
receives a portion of the contract value.
Fees and Commissions
The fees and commissions for annuities vary by the type of annuity. Fixed
annuities generally have the lowest fees.
Taxation
One of the most attractive features of annuities is their favorable tax
treatment from the IRS. If your annuity was purchased with money that you've
already paid taxes on, then only your earnings will be taxed when the money is
withdrawn.

Cash Now or Cash Later

Annuities come in two basic configurations: immediate or deferred.

The option you select will depend on your financial goals. If you want to begin receiving
annuity payments right away, you will choose an immediate annuity.

Alternately, if you would like to set your payments to begin at some point in the future,
you will purchase a deferred annuity and specify the start date in your contract.

 INCOME NOW

Immediate Annuities

Funded with a single lump-sum payment

Guaranteed monthly payouts

Supplement your retirement savings

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 INCOME LATER

Deferred Annuities

Tax-deferred premium growth

Guaranteed lifetime income that begins on the date you specify

More income later because your money accumulates longer

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 LEARN MORE

Types of Annuities
Different types of annuities exist to fit the diverse needs of the market. Your personal
goals and objectives will determine the type of annuity that is right for you.

 GUARANTEED INCOME

Fixed Annuities

Earns a guaranteed rate of interest for a set period of time

Rate of interest may be guaranteed for a set period of time or may fluctuate from
anniversary to anniversary

Backed by the insurance company that issued it

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 GROWTH POTENTIAL

Fixed Indexed Annuities

Earns interest based on a market index, such as the S&P 500

Doesn't participate directly in the stock market and preserves premium

Guaranteed minimum rate of return

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 FLEXIBLE INCOME

Variable Annuities

Earns interest through investments you select within the annuity

Does not guarantee a return but offers more growth potential

LEARN MORE

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Reasons to Buy an Annuity

People buy annuities to create long-term income. While most often considered financial
solutions for older people who are close to retirement, annuities can benefit investors of
any age with a variety of financial goals.
Reasons to buy an annuity include:

 Long-term security
 Tax-deferred growth
 Principal protection
 Probate-free estate distribution
 Inflation adjustments
 Death benefits for heirs
Income annuities are generally suitable for people who are within a year of retirement
and want the security of guaranteed income. Remember, single premium immediate
annuities (SPIAs) begin paying out within a year of purchase. This means there is no
accumulation period as there is with deferred annuities.

For this reason, SPIAs are also beneficial for younger people who have inherited a large
sum of money and wish to protect the windfall from poor financial management.

In contrast, deferred annuities are generally not recommended for people who have
short-term financial needs or younger people with more aggressive investment
strategies.

Annuity Benefits
One of the key benefits of an annuity is that it allows the investor to save money without
paying taxes on the interest until a later date. Annuities have no contribution limits,
unlike 401(k)s and IRAs.

Another significant benefit of annuities is the creation of a predictable income stream to

fund retirement. With an annuity, you don’t have to worry about outliving your savings.
This is a major advantage in the post-pension age.

Your reasons for investing in an annuity should align with your unique lifestyle and
financial situation.

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 

Tax-Deferred Growth

You save money without paying taxes on the interest until a later date.

No Contribution Limits

Unlike 401(k)s and IRAs, you set the dollar amount you invest.

Fund Your Retirement

Annuities create predictable income streams for life.

Provide for Your Family

Death benefit riders allow you to transfer your money to your loved ones.

Estimate Your Monthly Lifetime Income From an Immediate Annuity:

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PREMIUM AMOUNT
CALCULATE MONTHLY INCOME
*The dollar amount from this calculator is an estimate based on user-entered data. This
estimate does not constitute a binding agreement between you and Annuity.org or its
partners. We strongly urge you to consult with a financial advisor before purchasing an
annuity.

Disadvantages of Annuities
Some consumers see sacrificing liquidity in return for lifetime financial security as a
disadvantage. Indeed, if your financial status or short-term goals limit the amount of
cash you have on hand, an annuity is probably not the right solution for you. It wouldn’t
make financial sense to purchase a valuable, viable product if it’s not valuable and viable
for you.
Other common concerns about the structure and design of annuities include:

 Commissions and fees

 Complexity
 Conservative returns (as compared with investment products)
 Loss of potential returns from other investments
The loss of potential returns is what’s known as “opportunity cost.” People frequently cite
opportunity cost as drawback. This objection is valid for people with higher risk
tolerance. For example, younger investors with longer time horizons would most likely
benefit from a more aggressive investment strategy because they have time for their
money to grow and could bounce back from temporary market losses.

Older investors and retirees, on the other hand, need to assess opportunity costs as they
relate to their specific circumstances. It is less likely that people in this age group would
consider opportunity costs a disadvantage of an annuity.

Reduce Your Opportunity Cost

For many investors, the main objection to annuities is the risk of losing access to their
money for the length of their contract. This means that in addition to the possibility that
you won’t be able to cover unexpected expenses, you may miss the opportunity to take
advantage of higher interest rates or to invest in the stock market.

This is where your understanding of your long-term goals comes in. Your decision to
purchase — or sell — an annuity should be in alignment with your goals, and you should
be comfortable with having your money locked down for a modest payout in exchange
for guaranteed lifetime income.

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To reduce your opportunity cost, consider a partial investment upfront. This will allow
you to reserve some of your savings for unplanned expenses and give you the ability to
capitalize on a potential rise in interest rates.