How Annuities Work

The post How Annuities Work by Sarah Horvath appeared first on Benzinga. Visit Benzinga to get more great content like this.

An annuity is an insurance contract with pay-outs that act as a fixed stream of income for the future. Annuities are commonly used for retirement, as they help to ensure funds in the event your savings run out, but some annuity options offer pay-outs in addition to your current income. Annuities are a unique type of investment tool that can be used to create additional income streams. You can choose from multiple different types of annuities, each of which offers their own benefits and drawbacks.

How Do Annuities Work?

When you sign onto an annuity, over time, you’ll pay a certain amount of money into an annuity fund. In exchange, you’ll receive a lump sum back in the future, or you are paid a stream of income. In some cases, you may have the option to pay a lump sum upfront when you sign onto your annuity contract. The type of payout you receive is determined by the type of annuity you purchase. Annuities are essentially an insurance product and are distributed by financial institutions. 

You can use annuities as another source of cash flow and help pay for your standard of living in the case you outlive your assets. While the idea of an annuity seems basic, it can become more complicated depending on the way that your contract is set up. However, annuities can be used as an investment tool, which can make investing for retirement a lot less complex when compared to other types of retirement savings vehicles like IRAS or 401(k)s. 

Accumulation Period

Annuities go through different periods, the first being the accumulation period. This initial phase marks the period during which the annuity is being funded with your payments but before payouts begin. During this period, the money you invest is growing on a tax-deferred basis. The annuitization period begins once the payments begin being paid to you. 

Surrender Period

Annuities have what is called a surrender period, which is a period of time during which withdrawals made are subject to a surrender fee. The surrender period can last years, so you should consider this feature and look at other financial commitments you have before choosing which type of annuity you wish to purchase.

The use of an annuity is not to be cashed out in the future for a profit. Annuities are for trading a lump sum for guaranteed cash flow payments in the future, which is why it may not be the best option for some people, especially those who have a long period of time to invest and who want to see their initial investment grow in the future. 

Types of Annuities

There are several types of annuities available, each with its own set of features and benefits. Understanding these different types can help individuals make informed decisions when planning for their financial future. Let’s delve into the various options available for annuities.

Immediate Fixed-Income Annuities

Immediate fixed-income annuities are fixed annuities that have a set interest rate. These annuities require you to pay a set amount once in exchange for a stream of income over a certain period of time. The stream of income could last your entire life, or have a limit, depending on what your specific contract specifies. This type of annuity’s payments typically begin immediately after the deposit is made.   

Deferred Income Annuities

Deferred income annuities are also considered a fixed annuity. With deferred annuities, you pay a lump sum and then receive the stream of income over time. However, the stream of income is deferred for a period of time, meaning that you don’t immediately begin receiving your payments. This period of time, typically referred to as the accumulation period, can be months or even years long. During the accumulation period, the interest of your annuity will grow as you make payments into your account. In some cases, you are able to make more payments during this accumulation period in order to grow your future stream of income. 

Variable Annuities

A more complicated type of annuity is the variable annuity, as it is considered more of an investment. You decide where you want your annuity payments to be directed to, and the amount you are paid in the future is determined by your payments and the return on the investment. Fees and other expenses charged by the annuity provider reduce your future income. This type of annuity carries higher risk because while it could become a higher payout, you could also end up with a lower income during retirement than you hoped.

Indexed Annuities

This type of annuity is a combination of variable and fixed annuities. With indexed annuities you get a base income that is guaranteed; however, part of the stream of income is also determined by an index’s performance, such as the S&P 500. While this type of annuity gets some protection from major market drops, the trade-off is a lower benefit when the market is doing well.   

Benefits of Annuities

Annuities offer a range of benefits that make them a valuable investment option for individuals seeking financial security in the long term.

Guaranteed Income Stream

One of the main reasons for purchasing an annuity is to ease your mind for retirement. An annuity guarantees a stream of income during your retirement, so you don’t have to worry about your savings running out. 

Income Supplementation

If you plan to purchase an annuity that begins its income immediately — such as an immediate fixed-income annuity — then your annuity becomes a stream of money that is supplemental to your current income if you’re not retired yet. You can go on to invest this money if you’re currently in a comfortable financial situation and turn to the annuity as a supplemental income if your finances change.  

Simplicity

While some aspects of annuities can be complicated depending on the type you purchase, it’s still a simpler investment option than many other options. The simplicity of making a lump payment, or payments over time, then receiving a stream of income makes it an easier investment than most. 

Drawbacks of Annuities

While annuities can offer a variety of benefits, it is important to consider these drawbacks as well. 

Fees

All annuities come with a number of fees that can start to add up quickly. These fees could include insurance charges, rider fees, contract fees, surrender charges, investment management fees and many more additional charges that cut into the total value that you get from your annuity. The fees you’re charged depend on the insurance company and the type of annuity you purchase. 

Low Returns

When you purchase an annuity, you have to know that you may be giving up some other investments that may have higher returns. While returns on annuities can be good, you might still be able to get a higher payout when investing elsewhere. 

Compare Annuity Options

Beginning your search for the right annuity provider starts with reviewing some of the best-known market options. Benzinga offers insights and reviews on the following annuity providers — you may want to consider beginning your search using the links below.  

Should You Consider an Annuity?

The primary benefit of investing in an annuity is guaranteed, consistent payments, which can act as a major source of peace of mind during your retirement period. However, you should know that investing in an annuity also comes with the opportunity cost of other investments, which can produce greater returns over longer periods of time. Consider consulting a financial professional to learn more about how an annuity will impact your unique household finances and retirement timeline.  

Frequently Asked Questions

The post How Annuities Work by Sarah Horvath appeared first on Benzinga. Visit Benzinga to get more great content like this.