How Do Annuities Work?

Annuities can be a useful financial product to secure a steady income in retirement. An annuity is a long-term contract between you and an insurance company in which the insurer provides you regular payouts in exchange for a lump sum or series of premiums.

Whether annuities are a good investment for you depends on your financial goals and resources.

If you already receive a large pension or have another substantial source of retirement income, purchasing an annuity may not be a good fit.

However, if you’re like many Americans and don’t have a guaranteed income stream in retirement other than Social Security, you may consider buying an annuity. Annuities protect against the risk of outliving your savings.

Annuity contracts can be customized and structured to meet your specific needs and goals.

Annuities can be complex and they’re not for everyone. But like a pension or Social Security, annuities provide a way to supplement your living expenses in later life.

If you purchase an annuity and decide it’s not right for you, remember that many companies offer what’s known as a free look period. This time gives you a chance to review contract details and cancel the arrangement without penalty.

Annuities come in many forms. Each offers its own unique advantages and disadvantages.

Exploring the different types of annuities is a smart way to identify which one fits your needs and risk tolerance.

All annuities are taxed deferred. You won’t owe taxes on earnings until the money in your account is distributed or withdrawn.

Annuities offer add-on features, known as riders, that supplement other benefits, such as lifetime payments for your spouse or extra funds to pay for long-term care. These benefits cost extra money.

Fixed annuities are a straightforward, no-frills option. They carry the lowest risk and lowest fees.

Fixed annuity payouts are based on an interest rate specified in your contract. Payouts aren’t affected by fluctuations in the stock market, so they can offer peace of mind for risk-averse investors who want to ensure money for later life.

The size of variable annuity payments is tied to an underlying investment portfolio. You can choose from a range of investments. Mutual funds are the most common option.

Payments from variable annuities can increase if your subaccounts perform well but decrease if your investments lose money.

Variable annuities expose you to greater risk than fixed annuities, but they also allow you to reap the benefits of a strong market.

Variable annuities are the most complex annuity and typically carry the highest fees.

The size of your indexed annuity payments are tied to the performance of a broad market index, such as the S&P 500.

Indexed annuities let you benefit from gains in the stock market and guarantee a minimum rate of return no matter how poorly the market performs.

The value of an indexed annuity typically grows at a higher rate than a fixed annuity.

Unlike other investments such as stocks, bonds or mutual funds, annuities allow you to transfer the risk of outliving your retirement savings to an insurance company.

Annuities can help diversify your portfolio. Their stable and relatively safe nature can balance other higher risk investments that fluctuate with the stock market.