Personal FinanceEverything You Need to Know About Annuities And How They Work

SpenderrificOctober 11, 2021648 min

Are you looking for a source of guaranteed income in your retirement period? Out of many options available, you may opt for annuities. An annuity is an insurance product customized for your need. Annuities are not short-term investments but relatively long-term investments for you. 

What is an Annuity

An annuity is an insurance contract by which an insurance company promises you a fixed income for a lifetime or a specified period. You can purchase this insurance product with a lump sum or a series of payments that begins paying out immediately or in the future. In addition, you can invest in annuities as a way to fund retirement.

You can optimize the annuities as per your need based on income generation or long-term growth. However, they are not the ideal option for short-term investments. Nevertheless, if your goal is to have retirement income, preserve your capital, diversify your portfolio and secure your financial status in the future, annuities are an excellent choice for you. 

Types of Annuities

According to various details and factors, Annuities can vary, such as the duration of payments can be guaranteed to continue.

Immediate annuity

Do you need income right away? Or within 12 months? It would be better for you to consider an immediate annuity. It’s a good option for anyone interested in having a guaranteed monthly income. After you provide the insurer with a single lump-sum payment, they will distribute your income based on the schedule you decide.

Fixed annuity

A fixed annuity is an excellent long-term retirement investment for people who want to improve reliable interest rate stability. After you enter into a contract, you’ll receive a guaranteed rate of return each year on your premium — the amount you contribute. And, when you’re ready to retire, you can receive guaranteed income payments on the agreed frequency.

Variable annuity

If you want to invest your money over the long term and take advantage of the highs and lows of the financial market, look at variable annuities. They also allow you to earn tax-deferred savings up until you’re ready to start receiving guaranteed income payments. The insurer permits you to invest your annuity payments in various assets, like mutual funds. Your payout will vary based on how much money you put in.

How Does an Annuity Work

When retired, you need more money than the amount required for social security and investment savings to satisfy daily needs. An annuity works by converting a lump-sum premium into a series of income and providing you as you decide. When you buy a deferred annuity, the initial investment will grow as tax-deferred during the accumulation phase, typically anytime from ten to 30 years as per your contract. Once the annuity contract begins based on the terms of your agreement — you will start receiving regular payments. 

Annuities vs. Life Insurance

An annuity helps you prepare for the future, whereas life insurance enables you to protect your financial future.

Think of an annuity as a way or investment that helps satisfy your retirement needs. The primary purpose is to create income for you, which is possible in a few different ways. For example, you can schedule payments that last for your entire life, a specific period, or a combination of both.

The most significant difference between annuities and life insurance is that life insurance helps protect your family against a financial loss after you pass away. On the other hand, annuities help you financially grow while you’re still alive as it begins paying you off right away. 

Make up your mind

An annuity can be a reasonable means of securing a steady cash flow during your retirement and alleviating fears of the longevity risk of outliving your assets. Annuities are excellent financial products for you if you are seeking a stable, guaranteed retirement income. However, it would not be wise for younger ones, or those with liquidity needs to involve in annuities as the lump sum put into the annuity is illiquid and subject to withdrawal penalties.

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