Simply put, an annuity is an insurance product that pays out income, and can be used as part of a retirement strategy. Annuities are a popular choice for investors who want to receive a steady income stream in retirement.
Annuities can provide an incredible safety net. Older investors are particularly drawn to annuities as the threat of outliving their money from retirement accounts is a significant risk. Annuities can provide a guaranteed income stream for life, along with guarantee of principal.
Think of the annuity as your financial basement. Laying that foundation will guarantee you have the money to meet your living expenses.
In the past, people believed that annuities were for only wealthy individuals or families with a need to either shelter assets or ensure that large amounts of income would be guaranteed. But now more middle and lower income families are purchasing annuities to ensure that income continues in retirement. This is especially true as life expectancy for both men and women has increased dramatically of the last 40 years. Annuities are really the only investments that provide options for guaranteed income, a guaranteed return, or a guarantee of the Principal.
There are several variations and countless products to choose from, however they all share these common traits:
The taxes on the growth of an annuity are deferred. This in essence gives you a better rate of return than some other investment products, because the income that you would have paid in taxes is still working for you.
The safety offered with fixed annuities is perhaps the most important feature to most consumers. As long as you follow the contract rules, and the insurance company remains in good standing, the fund put into an annuity are never at risk.
Typically speaking, fixed annuities usually offer a higher interest rate than similar products, such as a bank CD or a money market account.
The traditional fixed annuity is structured very similarly to a bank CD (certificate of deposit). The premium grows at a guaranteed fixed interest rate for a set amount of time. The length of the contract can range anywhere from one year, to as long as 15 years.
Fixed Indexed Annuities, also referred to as Equity Indexed Annuities, provide the same principal guarantees of a traditional fixed annuity, however the rate of return is based on the performance of an index, such as the S&P 500. The insurance company will credit the account with a portion of the indexes upside growth, while offering protection against downturns in the market.
Immediate Annuities convert a lump sum amount of money into guaranteed income to the annuitant as soon as the annuity is purchased. The annuitant may choose from a lifetime income stream, which provided the income for life, or a set time frame (usually 5, 10 or 20 years).
The surrender charge of an annuity is the penalty or fee applied to the account if it canceled early. The most common structure is a decreasing surrender charge, where each year the surrender charge becomes smaller, until it is gone completely by the end of the contract length.
Premium bonus is a term used to describe a feature found on many annuities, in which the insurance company essentially adds ‘extra’ money to the account during the first year. The bonus can be in the form of a higher first year interest rate, or a partial premium match by the insurance company.