How do Annuities Work?

In your effort to research different types of investments and to properly allocate the funds in your portfolio, you may have come across the concept of annuities numerous times.

While annuities are commonly mentioned in many investment and personal finance planning articles and videos online, you may still not understand what they are or how they work. Before you can decide if an annuity is a solid investment that is right for your financial needs and goals, you must learn more about them.

Understanding Annuities

Annuities are typically offered through life insurance companies, and this is because they are considered an insurance product. With a typical life insurance policy, you make regular premium payments with the expectation that your beneficiaries will receive a lump sum payment of death benefits when you pass away. With an annuity, you pay into the annuity with monthly payments or with a lump sum amount. The insurance company than makes regular payments to you.

Annuities are considered a type of financial benefit because the money that is paid into the annuity may grow with a specified rate of return. Therefore, the total amount of money that you receive from annuity payments over the years may be greater than the amount of money paid into the annuity. The actual rate of return can vary based on numerous factors, such as interest rates at the time, the type of annuity you purchase and more.

Exploring Types of Annuities

The concept of buying an annuity may sound wonderful, and this is especially true if you are concerned about your ability to generate a specific rate of return on your investments through your own selection of investment products. The two primary types of annuities that you can choose from are a fixed annuity and a variable annuity, and there are many variations of each of these types of products.

A fixed annuity has a guaranteed rate of return and will pay out a specific amount of money over a specific period of time. Some fixed annuities have a lifetime term. A variable annuity has a variable rate of return and a variable payout. As is the case with a fixed annuity, a variable annuity may expire at a specific date or may continue to pay out over your lifetime.

Examining the Benefits of Annuities

Some people purchase annuities to provide them with their primary source of income in retirement. If you have debts to pay off, you may do so before retirement so that you can stretch your annuity income more substantially. Others invest a smaller portion of their funds in an annuity so that they can have at least a small amount of reliable income. A fixed annuity is beneficial because it has a guaranteed rate of return and can eliminate some of the guesswork associated with financial planning. A variable annuity is beneficial because you can take advantage of improved market conditions. However, you also may have to deal with declining market conditions.


Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

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