What is an Annuity?

An annuity is a financial product offered by insurance companies and designed to provide investors with a steady income stream in retirement. The basic idea is that investors make a lump sum payment or a series of payments, and then the annuity pays a specific amount back to them in regular distributions, which can then be used to cover essential, or other recurring, expenses. Depending on the type of annuity you choose, you may take that income either right away or at some point in the future.

Different types of annuities

Two of the most common kinds of annuities are deferred and immediate. The terms refer to when the products begin to offer an income stream.

  • With a deferred annuity, you don't withdraw income from the annuity for a couple years to even decades after you've funded the account – you save first, and then take income later.
  • In an immediate annuity, you can begin taking payments from the account almost as soon as you open it.

General benefits of annuity investing

  • Guaranteed income source. This can be especially valuable to retirees or pre-retirees who are concerned about losing money from their retirement savings in a downturn, or worried that they may outlive their savings. With an annuity, you fund the account and usually earn a pre-determined amount of interest, regardless of what happens in the stock market (this can be different with variable annuities).
  • Tax advantages. Annuities also offer the opportunity to defer taxes on the money you contribute to the account. But unlike other tax-deferred retirement saving accounts such as IRAs and 401Ks, there's no contribution limit to how much you can put away each year. They can provide a vehicle for tax-deferred savings if you've maxed out your other accounts.
  • No required minimum distributions. Traditional retirement accounts require that you begin making withdrawals at age 70 ½. Retirement annuities, however, don't carry that same stipulation, meaning the funds can continue to grow in the account until you need them.


Potential risks of investing in annuities

      • Missing the income benefit. The idea behind annuities is that you save money now in order to have an income stream for the rest of your life. If you suddenly pass away, then you would miss out on that long-term benefit. There are some annuities that allow you designate a beneficiary, but it may come with an extra cost.
      • Tying up money you may need.  Once you've invested your money in an annuity, it can be difficult to access it or cash it out if you suddenly need those funds.
        Example: Some immediate annuities cause you to lose access to your principal after you've invested it, even though the payments begin right away. Others offer access to the principal or time periods where you can take out larger amounts, but they may provide smaller monthly payments. Deferred annuities usually have a 10% penalty for making withdrawals before you turn 59 1/2.
      • Insolvent insurance companies. Because an annuity is a long-term investment, you'll want to make sure the company you buy it from is around for the long-term. Investors should investigate the credibility, history and credit standing of potential annuity providers.

Considerations for annuity investors

Annuities can be complicated products, and it's important that investors understand the details before they invest. These include any associated fees, penalties for early withdrawals, how payouts are determined and what happens to the account if you pass away. In addition, annuity payments don't usually account for inflation, which is something investors should consider.

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