An annuity works by providing a reliable stream of income over a specified period, often during retirement. When you purchase an annuity, you’re essentially entering into a contract with an insurance company. You make either a lump-sum payment or a series of payments into the annuity, which is called the “premium.”
Once the annuity is funded, the insurance company invests the money on your behalf. The way your money is invested depends on the type of annuity you choose:
- Fixed Annuities: With a fixed annuity, your premiums are invested in conservative, fixed-income investments such as bonds. The insurance company guarantees a minimum interest rate on your investment, providing a predictable income stream.
- Variable Annuities: Variable annuities allow you to choose from a range of investment options, such as mutual funds. Your returns are tied to the performance of these investments, offering the potential for higher returns but also greater risk.
The income payments from an annuity can begin immediately (immediate annuity) or be deferred to a later date (deferred annuity). During the accumulation phase, your investment grows tax-deferred, meaning you don’t pay taxes on the earnings until you start receiving income from the annuity.
When it’s time to start receiving payments, you have several options:
- Fixed Payments: You receive a fixed amount of income for a specified period or for life.
- Variable Payments: Your payments fluctuate based on the performance of the underlying investments.
- Guaranteed Payments: Some annuities offer guaranteed minimum payments, providing a level of financial security regardless of market conditions.
Overall, annuities can be a valuable tool for retirement planning, offering tax-deferred growth, a reliable income stream, and the potential for financial security in retirement.
