An annuity refers to a type of financial contract or product bought by an individual from an insurance or financial services company with the promise of receiving regular payments later. A typical example of an annuity is a pension plan in which an individual pay during working years to receive an amount at a periodical period after retirement.
Annuities provide a secure, guaranteed income for a lifetime or a fixed term of your choice. They could be used as the foundation of your retirement plan.
Annuities are great because they provide guaranteed monthly income in retirement that doesn’t depend on how much money you have in your bank account or how long you live.
Annuity Terminology
- Annuity: A series of payments that are made or received.
- Ordinary Annuity: A cash flow level at the year’s end.
- Annuity Due: A level of cash flow at the beginning of the year.
The future and the present value of annuities could be calculated using formulas that accommodate multiple cash flows.
Understand Different Types of Annuities
An annuity is paid based on the investment portfolio in which the contribution is made; for example, depending upon an investor’s risk profile, an investment portfolio or contract could be chosen. This investment portfolio could be market-based with variable returns depending upon the stock market performance or a safer portfolio in which investment is usually protected, for example, a portfolio comprising government securities.
Payout of annuities could be Fixed, Variable, or Fixed Indexed.
- Fixed Annuity: This option has the least risk and the most predictability. Fixed annuities come with a guaranteed amount over some time.
- Variable Annuity: A variable annuity comes with more risks and potentially higher rewards. For example, payments from variable annuities can increase if the portfolio does well, but they can also decrease if the investments lose money.
- Indexed Annuity: The indexed annuity, also known as equity-indexed annuities and fixed-indexed insurance products, have fixed and variable annuities characteristics. It’s a way to balance the risks and rewards, carrying lower risks than variable annuities and higher income potential than fixed annuities.
Different Types of Annuity Payout Options
- Immediate Annuity: With an immediate, also known as an income annuity, the annuity holder begins receiving payments within a year or soon after purchasing the annuity contract. Many life insurance companies offer immediate annuity plans. These plans could be considered an efficient tool for retirement planning.
- Deferred Annuity: With a deferred annuity plan, an investor receives payments that start in the future or after some time, for example, after five years or more. Typically, this happens when an investor invests the amount in an annuity plan until he retires and soon after retirement starts getting the annuity. In the meantime, the investment usually grows on a tax-deferred basis.
- Fixed-Period Annuity: A fixed-period annuity, also known as a term-certain annuity, is receivable for a pre-defined period, say ten years. This period may change as per the annuity contract. With these annuities, the age and health of the annuity holder do not affect the amount of the payments.
- Life-only Annuities: These annuities guarantee an income stream for the annuity holder’s lifetime. Sometimes, lifetime annuities allow a beneficiary to receive payments after the annuitant’s death. With these annuities, the payment amount would be based on the health and age of the annuity holder. However, you may choose provisions that provide grants to your spouse or even a refund.
- Life Annuities with Period Certain: In this type, an annuity is paid for a certain number of years even if the annuitant dies before the end of the period.
- Joint and Survivor Annuities: It provides annuity payments over the annuitant’s and beneficiary’s lifetime.
Conclusion: Choose an Annuity that Fits Your Retirement Income Needs
Annuities have been around for a long time. They are a contract between an individual and an insurance company to provide payments for life. Annuities can be fixed or variable, and they are tax-deferred.
Many people choose annuities as their retirement income source due to their benefits. However, before you go ahead with this decision, you should consider your needs and the needs of your spouse and other family members.
