An annuity is a great option for anyone to create a stable source of income in their life. However, it can be confusing if you aren't sure what an annuity entails. Let me break down the ABCs of annuities for you.
Here’s a very simple definition to serve as our foundation. Annuities are a contract between an individual and their insurance company or financial institution. They guarantee that the investor or the annuitant will be given a fixed income for a fixed period of time. This may be, but isn’t always, the annuity holder’s lifetime.
What is the Basic Function of an Annuity?
An annuity is a way of providing a specific source of income for a specific period of time, as Investopedia explains. Annuities are typically thought of as an insurance product because they can help you manage your retirement income.
There are annuity options if you want to be more financially stable in your old age. The ABCs of annuities can help you understand the basic concepts and features of these insurance products.
The basics of annuities in terms of benefits are:
- Annuities can provide you with guaranteed income to ensure that you have an adequate life in retirement. Whether it's for a set period of time or the rest of your life, annuities can be set up so that they guarantee an income stream.
- Annuities have tax-deferred growth. This means that the investment earnings on an annuity aren't taxed until it is used, which gives you many benefits such as tax savings and starting off with more money.
- Annuities offer a range of options for payments and beneficiaries, including the ability to customize the annuity to suit your specific needs and preferences. This gives you flexibility in your financial planning.
How Do Annuities Work?
If you're new to annuities, it's important to learn the ABCs of annuities before making any decisions. There are two phases of annuities:
- Accumulation — when the funds invested grow
- Distribution — when the funds invested are paid out
You can purchase an annuity contract from an insurance company or financial institution. When you do this, you can pay a premium (a series of payments) or you can pay a lump sum. These contributions are invested by the insurance company in a variety of investment vehicles. These can be stocks, bonds, or mutual funds, depending on the type of annuity.
Based on the type of annuity you purchase, you can start receiving a series of regular payments over a specific period of time or the remainder of your life. If you choose, you can make withdrawals from your annuity as you need to or even leave the funds invested for use at a later date.
Different annuities have different tax treatments. They may be subject to tax based on the type of annuity you have. If you pass away before receiving all of the payments from an annuity, then you can have the remaining balance paid to a beneficiary — if you have an annuity death benefit.
Your annuity contract details can vary depending on specific companies and the type of annuity it is. You should carefully review the terms and consult with a financial advisor about which type of annuity is right for you.
It's important to take a close look at annuity options and compare them before deciding whether or not one is for you. A financial advisor can help you navigate the ABCs of annuities and select the right type of annuity for your individual needs and circumstances.
What Are the Basic Types of Annuities?
When you look around, you might find conflicting information about the types of annuities. When looking at how annuities function and operate, there are three types of annuities:
- Fixed annuities
- Fixed-index annuities
- Variable annuities
In terms of payouts and distributions, there are two basic types of annuities. These are
- Immediate annuities
- Deferred annuities
Immediate annuities are annuities where the distributions start almost immediately. An immediate payment annuity is also referred to as a single-premium immediate annuity (SPIA). Contributions made to this type of annuity are made in a lump sum.
Deferred annuities are insurance contracts where the distributions or payouts start at a later date. The payout can be a lump sum or a series of periodic payments. Contributions are usually made over time, allowing earnings to grow.
Find the Right Annuity Contract for You
While the ABCs of annuities are important to understand, it's also important to carefully review the terms and conditions of any annuity contract before making a purchase.
The terms and conditions of an annuity contract should suit your long-term goals. That's why it’s essential for you to consult with a financial advisor before making a purchase.
Call the pros at Asset Preservation & Wealth for a complimentary portfolio review and consultation!
Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products. They do not refer in any way to securities or investment advisory products. Fixed insurance and annuity product guarantees are subject to the claims paying ability of the issuing company; not guaranteed by any bank or the FDIC.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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