What are Annuities?
An annuity is a financial agreement between you and an insurance company, where the company agrees to make payments to you either right away or at a later date. You can purchase an annuity with a one-time payment or through multiple payments over time. In return, the money you receive can come as a single lump sum or as a series of payments spread out over a period of time.
Why do people buy annuities?
People often purchase annuities to help create a reliable income stream during retirement. Annuities offer three main benefits:
• Guaranteed payments over a set period of time—this could last for your lifetime, your spouse’s lifetime, or another designated person.
• Death benefits, which ensure that if you pass away before receiving payments, your named beneficiary will receive a designated amount.
• Tax-deferred growth, meaning you won’t pay taxes on the earnings or investment gains until you begin making withdrawals.
What kind of annuities are there?
There are three primary types of annuities—fixed, variable, and indexed—and each works differently depending on how your money is invested, how returns are calculated, and how risk is managed. Understanding these differences is key when deciding which type of annuity best fits your financial goals and retirement needs. Here’s a deeper look at how each one functions:
Fixed Annuities
A fixed annuity offers stability and predictability. With this type, the insurance company guarantees a minimum interest rate on your contributions and commits to making regular, fixed payments to you over a set period—often for the rest of your life. Because of this predictability, fixed annuities are especially appealing to conservative investors or those seeking guaranteed income in retirement.
Fixed annuities are not directly tied to the performance of the stock market, which means your earnings are shielded from market downturns. However, this also means they typically offer lower returns than variable or indexed options. Fixed annuities are regulated by state insurance commissioners, so it’s important to consult your state’s insurance department for specific rules and consumer protections. Before purchasing, confirm that your insurance broker is licensed to sell annuities in your state and ask about any surrender charges or penalties for early withdrawal.
Variable Annuities
A variable annuity gives you the opportunity to earn higher returns by investing your contributions into a selection of investment options, usually mutual funds. The performance of your annuity is directly tied to the success of these underlying investments. This means your payouts can increase—or decrease—depending on market conditions, the amount you’ve invested, and any associated fees.
While variable annuities offer growth potential, they also carry more risk than fixed annuities. They’re best suited for individuals comfortable with market fluctuations and a longer investment horizon. Because they are considered securities, variable annuities are regulated by the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). These annuities often come with features such as optional death benefits or income guarantees, but these benefits may come at an additional cost.
Indexed Annuities
Indexed annuities are a hybrid product that blends elements of both fixed and variable annuities. Your returns are linked to the performance of a specific market index—commonly the S&P 500—but with built-in protections against market losses. In most cases, you’ll receive a guaranteed minimum return, along with the potential to earn more if the market performs well.
However, returns on indexed annuities are typically subject to a cap or participation rate, meaning you may only receive a portion of the index’s gains. For example, if your annuity has a 70% participation rate and the index goes up by 10%, you would be credited with a 7% return. These annuities are regulated by state insurance commissioners, not the SEC, and like fixed annuities, it’s important to verify your broker’s licensing and understand the product’s terms before investing.
In Summary
Each type of annuity serves a different financial purpose. Fixed annuities prioritize security and predictable income, variable annuities offer growth potential with market risk, and indexed annuities attempt to strike a balance between safety and upside potential. Carefully reviewing each option—and consulting a qualified financial or insurance professional—can help you choose the right annuity for your retirement strategy.
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