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How Does An Annuity Work

How Does An Annuity Work

An annuity is a financial product that is designed to provide a steady stream of income for a predetermined period or for the rest of your life. It is essentially a contract between you and an insurance company, where you make a lump sum payment or a series of payments, and in return, the insurance company promises to make regular payments to you in the future. Annuities can be a valuable tool for managing longevity risk, which is the risk of outliving your savings.

Annuities are often considered a long-term investment, as they are primarily used for retirement planning. There are various types of annuities, and each has its own set of rules and features. Annuities also offer tax-deferred growth, meaning the money within the annuity compounds without being reduced by taxes until withdrawals are made. Let’s explore the different annuity types and annuity basics to help you determine if they fit into your financial plan.

Fixed Annuities

Fixed annuities are one of the most popular types of annuities. As the name suggests, they offer a fixed interest rate, which means your payments will not vary, regardless of market fluctuations. This type of annuity provides a guaranteed rate of return, making it a low-risk investment option. It’s an appealing choice for those who prioritize stability and predictability in their retirement income.

With a fixed annuity, you make a lump sum payment or a series of payments to the insurance company, and in return, you receive regular payments at a fixed interest rate for a predetermined period. This type of annuity is often used as a way to supplement retirement income and provide a stable source of income. It’s particularly suitable for retirees who are wary of the stock market’s ups and downs and prefer a guaranteed income stream.

Variable Annuities
Variable Annuities

Variable Annuities

Variable annuities, on the other hand, offer a variable rate of return. This means that your payments will fluctuate based on the performance of the underlying investments. With a variable annuity, you have more control over your investments, as you can choose from a variety of investment options, such as stocks, bonds, and mutual funds. This type of annuity can be part of a balanced financial strategy for those seeking growth potential in their retirement savings.

While variable annuities offer the potential for higher returns, they also carry more risk compared to fixed annuities. If your investments perform well, you may receive higher payments, but if they perform poorly, your payments may be significantly lower. This type of annuity is best suited for those who are comfortable taking on more risk in their retirement planning and have a longer time horizon to ride out market volatility.

Immediate Annuities

Immediate annuities are designed to provide a stream of income right away. This type of annuity is typically purchased with a lump sum payment, and in return, you receive regular payments for the rest of your life or for a predetermined period. Immediate annuities are often used by those who are already in retirement and want to supplement their income. They can be a particularly good choice for retirees who want to convert a portion of their savings into a predictable income stream immediately upon retirement.

Deferred Annuities

Deferred annuities, on the other hand, are designed to provide income at a later date. With a deferred annuity, you make payments to the insurance company over time, and the income payments will start at a future date, usually when you retire. This type of annuity is often used as part of a long-term retirement plan. It allows individuals to accumulate savings on a tax-deferred basis, and then convert those savings into a stream of income in the future.

Deferred annuities can be fixed or variable, offering a range of investment and payout options. They are particularly attractive to individuals who are still in their working years and are looking to grow their retirement savings with the added benefit of tax deferral.

How Do Annuities Work?

When you purchase an annuity, you are essentially entering into a contract with an insurance company. The terms of the contract, such as the payment amount and frequency, are determined at the time of purchase and cannot be changed. The insurance company then invests your money, and when it’s time to receive payments, they use a portion of the investment earnings to make the payments.

The amount of your payments will depend on various factors, such as the type of annuity, your age, and the length of the payout period. For example, with a fixed annuity, your payments will be based on the amount you invest, the interest rate, and the length of the payout period. With a variable annuity, your payments will depend on the performance of your investments, as well as your chosen investment options and market conditions.

What Are the Benefits of Annuities?

Annuities offer several benefits that make them an attractive investment option for retirement planning. Let’s take a look at some of the main benefits:

Guarenteed Income
Guarenteed Income

Guaranteed Income

One of the main benefits of annuities is that they provide a guaranteed stream of income during retirement. This can provide peace of mind and help you plan for your retirement with more certainty. Knowing that you have a reliable income can alleviate the stress associated with market downturns and economic uncertainty.

Tax Benefits

Annuities offer several tax benefits, making them a tax-efficient investment option. For example, any gains within the annuity are tax-deferred, meaning you won’t have to pay taxes on them until you start receiving payments. This can be beneficial if you are in a lower tax bracket during retirement, as it may result in lower overall tax payments on your annuity income.

Investment Options

With annuities, you have control over your investments, allowing you to choose from a variety of options, such as stocks, bonds, and mutual funds. This gives you the opportunity to potentially earn a higher return on your investment. For those with a more aggressive investment strategy, variable annuities provide the flexibility to tailor their portfolio according to their risk tolerance and financial goals.

What Are My Annuity Options?

When it comes to annuities, you have several options to choose from. Let’s take a look at the different types of annuity options:

Single-Premium Annuity

A single-premium annuity is a type of annuity that is purchased with a lump sum payment. This payment can come from a variety of sources, such as an inheritance or a retirement account. With a single-premium annuity, you make one payment, and in return, you receive regular payments for the rest of your life or for a predetermined period. It is a straightforward option for those who have a sum of money they wish to convert into a lifetime income.

Flexible-Premium Annuity

A flexible-premium annuity is a type of annuity that allows you to make multiple payments over time. With this type of annuity, you can choose how much and how often you make payments. This can be beneficial if you want to invest smaller amounts over time rather than a lump sum, providing flexibility for those who may have irregular income or who prefer to fund their annuity gradually.

Fixed Period Annuity
Fixed Period Annuity

Fixed-Period Annuity

A fixed-period annuity is a type of annuity that provides payments for a predetermined period. This can be beneficial if you want to receive payments for a specific number of years, such as during your retirement years. It can help bridge the gap between retirement and other income sources, such as Social Security, which might start later.

Life Annuity

A life annuity is a type of annuity that provides payments for the rest of your life. This can be a good option if you want to ensure a steady stream of income during retirement, eliminating the worry of outliving your assets. Life annuities can also offer options such as death benefits and inflation protection to further customize your retirement plan.

News

US stocks saw ups and downs on Friday after a significant jobs report revealed stronger-than-expected hiring growth. While the S&P 500 and Dow Jones Industrial Average made slight gains, the Nasdaq Composite remained stable. Investors were anticipating data indicating an economic slowdown, but the report suggested ongoing strength, potentially delaying expected interest rate cuts. 

The report unveiled a substantial addition of 272,000 jobs in May, surpassing expectations, although the unemployment rate rose slightly to 4.0%. Elsewhere, investors awaited a livestream event and the completion of a stock split. Stock prices fluctuated after a company announced a stock sale and reported quarterly results below estimates.

In Conclusion
In Conclusion

In Conclusion

Annuities are a complex financial product, but they can be a valuable addition to your retirement planning. With various types and options to choose from, it’s important to do your research and consult with a financial advisor to determine which annuity is right for you. By understanding how annuities work and their potential benefits, you can make informed decisions that will help you achieve your retirement goals and enjoy a secure financial future.

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