What exactly is an annuity?

An annuity is an insurance product.

How it works is, you make either a lump sum payment or a series of payments, and the money grows tax-deferred at a fixed or variable rate, this is called the accumulation phase. The insurer agrees to make periodic payments to you for the rest of your life, in return. This is known as the payout or annuitization phase. There is also a death benefit that comes with annuities that entitles your beneficiary to the value of your annuity or a guaranteed minimum, whichever is greater. So this is where the insurance comes in.

Keep in mind that there are a lot of ins and outs you should be aware of. For instance, you will have to pay a surrender fee if you tap the annuity before a certain period that is laid out in the contract.

What type of annuities are there?

There are many different annuity products, but deferred annuities fall into three main categories:

Fixed annuity.

This is where you lock in a guaranteed rate of return for periods ranging from one year to ten years. Although rates can fluctuate they will never drop below your guaranteed rate. So while you won’t lose money, you won’t have the potential for growth that you would get by investing in stocks or stock funds. If you have low risk tolerance and a shorter time horizon for when you need the money a fixed-rate annuity is worth considering. If you meet the annuity-buyer profile.

Variable annuity.

This is when the money is invested in accounts similar to mutual funds. You can see substantial gains or watch the value of your account plummet, just like investing in a regular mutual fund. You will want to consider that you will pay higher fees for the annuity. It can make sense in certain cases if a variable annuity is cheap enough. Outside an annuity, the part of the inheritance attributable to unrealized capital gains would be tax-free.

Equity-indexed annuity.

You get a guaranteed rate and fixed payments with this product much like a fixed annuity. However, since it’s tied to an index such as the Standard & Poor’s 500, it provides more opportunity for growth.

Is an annuity right for me and my retirement income goals?

An annuity may not be a good option for short-term saving.  For example, you pay higher tax rates and higher expenses for the funds in the annuity than you’d pay for funds outside the annuity with a variable annuity. So you would need to hold an annuity at least 15 years for the benefits of tax deferral to outweigh the extra costs.

You might be a good candidate as an annuity buyer if you’re concerned about outliving your savings, because annuities can provide a guaranteed stream of income in retirement.


Are there any fees for an annuity?


Fees and commissions are factored in and lower your yield with fixed and equity-indexed annuities  to cover the risk the insurance company takes on to pay you lifetime income. Variable annuities have a mortality and expense charge. Typical annual fees run 2%.

If you withdraw money early there is the surrender fee that applies. Fixed and equity-indexed annuities are subject to these fees also. These penalties average 5.5% but generally phase out after you’ve been in the annuity for a few years.


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