What Is an Annuity?
Whether you’re saving for retirement or looking to create guaranteed retirement income, an annuity can be an important part of your financial plan.
When you’re planning for retirement, you may hear the word “annuity” mentioned as one way to help you create income for retirement. But what is an annuity? In this guide, we’ll help break down the different types of annuities, tackle some common annuity myths and explain how an annuity can be an essential part of your retirement planning.
What’s in our guide to annuities?
Section 01 What is an annuity?
An annuity is a type of financial product you can get from an insurance company that lets you set money aside to create guaranteed income in retirement. Whether retirement is decades away and you’re still saving or it’s right around the corner, adding an annuity to your financial plan can give you more certainty than using investments alone.
But how does an annuity work? We’ll help you understand the different kinds of annuities and what you should know about them, as well as how annuities can work with other financial tools to help you feel more confident about your retirement.
Income Annuity: A 'Paycheck' for a Lifetime
Section 02 What are the different types of annuities?
While there are many different types of annuities, they typically come in two main varieties — annuities that help you accumulate funds for retirement and annuities that help you create guaranteed income in retirement.
Accumulation annuities are types of annuities that help you save for retirement. You make a single contribution or contributions over time into the annuity, and the value of your annuity can grow over time at either a fixed or variable rate. With a fixed or variable annuity, you could eventually convert the value of your annuity into an income stream for retirement or withdraw your money for other purposes.
An income annuity is designed to help you create guaranteed income, usually in retirement. These are typically purchased with a single contribution in retirement or in the years leading up to retirement. The annuity will then begin making regular payments back to you that can be guaranteed to continue for as long as you live.
Within each category of annuity, you have additional options.
What kind of annuity makes sense for you?
Our financial advisors can help you learn more about the different types of annuities and which one might be right for your situation.
Connect with an advisorSection 03 Types of accumulation annuities
Fixed Annuity
As the name suggests, this type of annuity grows at a fixed rate, similar to a certificate of deposit you’d get at a bank. Because of the fixed rate, you know exactly how your money will grow over time. While there may be penalties and fees if you withdraw money from a fixed annuity before hitting certain time or age milestones, you could eventually take your money as cash or convert it into a stable stream of income.
Variable Annuity
Variable annuities also fall under the accumulation annuity category but grow at a variable rate, as they can have some exposure to the stock market. The growth is tied to the performance of investment fund subaccounts that you choose. With a variable annuity you will also be able to withdraw your money after certain milestones or convert the value of your annuity into an income stream.
Section 04 Types of income annuities
Immediate income annuities
Immediate annuities are income annuities that start paying you regular income shortly after you pay a lump sum. These fixed payments will typically continue for the rest of your life or some other specified period of time.
Deferred income annuities
Deferred income annuities are very similar to immediate annuities. The big difference is that you don’t receive income payments immediately — instead, payments are deferred until a future date. For the same cost, a deferred income annuity will typically have higher payments than an immediate income annuity.
Portfolio-based income annuities
Portfolio income annuities offer many of the same benefits as other income annuities, and they have the potential to grow based on company performance. Here’s how it works: With a portfolio-based annuity, you are guaranteed a minimum level of income, but that income can grow through dividends. While dividends aren’t guaranteed, a company can choose to pay them based on yearly performance. If a dividend is paid, you would typically have flexibility to take it as a distribution in cash or use it to increase the amount of all future income payments.
Portfolio Deferred Income Annuity
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Section 05 How an annuity works in a retirement plan
Retirement should be an exciting time. With the right planning, you’ll ideally be able to enjoy 20 to 30 years of life however you want — and work only if you want to, not because you need to. But 20 or 30 years is a long time to live off your savings. When you build a retirement plan for living longer, there are several risks that you’ll want to consider. These risks include:
Retirement risks
Longevity
Market volatility
Inflation and taxes
Health care
Long-term care
Legacy
A solid retirement plan will use a mix of different financial tools — including investments, Social Security and even permanent life insurance — to help you address these risks. But annuities can play a key role when it comes to protecting your plan from market volatility and longevity. And they can also help with many of the other risks. Here’s how an annuity can help:
Longevity. Helping account for longevity is the primary function of an annuity. Most are designed to make payments to you no matter how long you live. This means you don’t have to worry about running out of money if you happen to live longer than you thought you would.
Market volatility. Income annuities aren’t tied to the markets. That means your payment amount will be consistent every month regardless of whether the markets are down or we’re in the middle of a recession.
Inflation and tax efficiency. Annuities offer some tax advantages that could help make your dollars go further, depending on your situation. And the growth potential of portfolio annuities can help protect your future income from inflation.
Legacy. While annuities don’t contribute directly to the money you leave behind, you can name a beneficiary for certain annuities so that a loved one can receive continuing payments or get back at least what you put into the annuity should you die earlier than expected.
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Our advisors can help account for various risks to your retirement so that you can feel confident you'll live the retirement you want.
Get startedSection 06 Common annuity myths
While annuities can be a great part of a retirement plan, several myths about them have grown over the years. Take this quiz to discover a few of those myths and the real story about annuities.
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Section 07 What happens to your annuity when you die?
This is a common question when people are considering an annuity.
Ultimately, what happens to the money in an annuity when you die will depend on the type of annuity you get and how you structure it. But there are many ways to ensure that your loved ones are taken care of if you pass away unexpectedly.
First, if you have a fixed or variable accumulation annuity (one that helps you save for retirement) and haven’t converted it into income, the value of the annuity will pass to your beneficiaries when you die. In fact, many variable annuities come with a guaranteed death benefit, so your loved ones get back at least what you put into it.
If you have a deferred income annuity (which starts paying out a regular income after a pre-determined period) and you die during the deferral period, your beneficiaries can typically get the full value of the policy.
Once you start taking payments, you can add a number of options to your annuity that affect how long you receive payments and help to ensure your money is passed on to your heirs if you die before a certain date. It’s important to point out that all these features come at a cost. The more guarantees you add, the lower your monthly payment will be unless you increase your upfront payment.
Annuity features you can add
Life with refund guarantees that you or your beneficiary will get at least the amount you paid into the annuity. Payments to you are guaranteed for the rest of your life. If you die before the amount of your contribution is paid out, your beneficiary will continue to receive payments up to the initial amount paid.(And with a portfolio annuity, beneficiaries could also get more than the initial amount you paid in from interest and dividends that were used to purchase additional income.)
Joint and survivor bases the payments on two lives. Couples typically use this option. The payments will continue until the second person dies. You could also opt to have the payments decrease after the first person dies. Doing so results in larger payments while both people are still alive.
Life with period certain will guarantee that payments last for a certain number of years, for you or your heirs (say 10 or 20 years). If you die prior to the end of the period certain, your beneficiary will get the payments. Payments otherwise will continue for as long as you live.
Period certain only is an annuity that lasts for a certain number of years and then stops making payments. If you die before this time limit is reached, your heirs will get the remaining payments — but if you outlive the time span, your payments will stop as well.
Consider speaking with a financial advisor to see which type of annuity and which features make the most sense for you — and can help you be more confident you’ll have the income you need for retirement.
Section 08 Conversation starters with an advisor
How much can I put into an annuity?
Does it make sense for me to get an annuity now or closer to retirement?
How can I access my money once I’ve put it into an annuity?
What are the annuity fees?
What happens to my money if I die sooner than expected?
What's the financial stability of the annuity provider?
