An annuity, in simple terms, is a type of insurance product that represents a long-term contract between an individual and an insurance company. In exchange for a premium payment, or a series of payments, the insurance company guarantees a stream of income payments. These payments can begin immediately or can be deferred for future income
Annuities are designed to provide retirement income. Therefore, they are best suited for those in or near retirement.
Annuities may be immediate or deferred. Deferred annuities experience growth until their maturity date, which is when income payments begin. Payments can be structured to last for a certain number of years, for an entire life, or a combination of both. Many annuities also have a death benefit that is paid to the annuity’s beneficiary in the event of the owner’s death.
All annuities are either immediate or deferred. In addition, annuities may be fixed, indexed, or variable. As the name suggests, fixed annuities grow at a stated interest rate. Indexed annuities can earn interest based upon the performance of a stock index, such as the S&P 500. Although indexed annuities can experience market gains, they are usually protected from downside loss. Variable annuities perform based upon the performance of underlying subaccounts, which function much like mutual funds. Variable annuities have unlimited potential for gains, but they can also lose money if the subaccounts underperform.
The most significant benefit of annuities is their unique ability to offer a stream of income that is guaranteed for life. This can provide peace of mind that few other investments can offer. In addition, annuity earnings accrue on a tax-deferred basis, allowing gains to compound quicker than they otherwise would. A final major benefit is that annuity death benefits are payable directly to the beneficiary, avoiding the cost, publicity, and delay of probate.