An annuity is a series of regular payments made over a set period of time.
Annuities can be purchased from insurance companies, and they’re often a popular option for retirees. By using your life’s savings to buy an annuity, you can convert a lump sum of cash into a steady stream of income. You could also receive an annuity from a legal settlement, an inheritance, or lottery or game show winnings.
The most basic version of an annuity works like this:
You pay an insurance company a
large lump sum of money, like $500,000
The insurance company starts paying you
a small sum of money every month, like $1,500
You receive that $1,500 every month for
the rest of your life
When you die, the insurance company
stops making payments
But in real life, there are almost endless variations on that basic version.
There are three main types of annuities:
You can also choose between immediate and deferred annuities.
Whether an immediate or deferred annuity is best for you typically depends on whether or not you’re already retired. Retirees who want payouts right away might prefer immediate annuities, whereas deferred variable annuities are better suited for those saving up for retirement.
In addition to those main varieties, there are a range of additional features annuity buyers may be able to choose from:
|Cost of living adjustment||Payouts increase with the rate of inflation|
|Death benefit||If you die before the annuity has paid out a certain amount, it will pay an additional sum to your beneficiaries|
|Guaranteed withdrawal benefit||Lets you withdraw a certain portion of the money you’ve paid in|
|Joint life||Payments continue as long as you or your spouse is still alive|
No matter which type of annuity you choose, you won’t pay taxes as your account grows. But, any payouts you receive are generally taxed as income (like wages you receive from your job).
One major drawback of annuities is that they can come with high fees. Some of the fees they might charge include:
Annuities and life insurance policies are both contracts offered by insurance companies, but they are offered for two very different purposes:
Annuities can be a great source of steady income for retirement with some tax benefits. There are many different types of annuities to choose from, so carefully consider your needs before you buy one and be sure to understand the fees of any annuity you consider.