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How Annuities Work

An annuity is simply a way you can save for your retirement. Insurance firms sell annuities as products. When you enter into a contract with them and purchase an annuity, they promise to make payments to you beginning today (called an Immediate Annuity) or later (Deferred Annuity).

There are no limits on the amount you can invest in your annuity, unlike IRAs (individual retirement accounts) and similar plans.

Forms of Annuity

Annuities are either of two basic forms:

  • Fixed – This is an annuity through which you can get a fixed income over a certain period.
  • Variable – This annuity gives you the option to allocate your money across several sub-accounts that function as mutual funds.

Types of Annuity Premiums

These two types of premiums can take the form of fixed or variable annuities.

Single premium annuities – This means that you pay only an initial amount or lump sum premium for the contract to begin.

An example of how it works: The insurance company sets a minimum deposit amount. This minimum can be lower if the deposit comes from a company retirement package. If you feel that your annuity is too low and you want to invest more, simply set up a new contract.

When you make a deposit, you specify a maturity date when collected funds can be distributed to you in staggered payouts like a pension (maximum age varies, but is usually age 85 or older) or a lump sum settlement.

Flexible premium annuities – This means that you can make periodic premium payments into your account.

An example of how it works: Insurance companies generally offer you the option of automatic monthly withdrawals from your bank account, or you can choose to pay when you want. Your annuity fund increases as you make deposits to it, as well as through investment earnings. Payouts begin when you retire or at the time you specify. Payouts can be made to two people or an individual.

Are Annuities a Good Choice for You?

If you are self-employed, an annuity may be another way–aside from Social Security–that you can have a source of income after retirement.

An annuity is also a good, tax advantaged alternative for you if you have already maximized other retirement savings options.

Finally, annuities are a good choice for you if you fall in the higher tax brackets since tax-deferred savings become less beneficial for lower tax rates.

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