Annuities are primarily sold by insurance companies and are designed to provide a steady income stream, often during retirement. They can be an important tool for managing longevity risk—the risk of outliving your savings.

Types of Annuities

Fixed Annuities

Fixed annuities provide guaranteed payments of a specific amount. The insurance company assumes the investment risk and promises a minimum rate of return. These are the simplest and most predictable type of annuity.

Variable Annuities

Variable annuities allow you to invest your funds in various sub-accounts, similar to mutual funds. Your payments will vary based on the performance of these investments. While they offer growth potential, they also come with investment risk.

Indexed Annuities

Indexed annuities offer returns based on a specific market index (like the S&P 500), typically with some downside protection and capped upside potential. They provide a middle ground between fixed and variable annuities.

Annuity Payment Structures

Immediate Annuities

Payments begin shortly after making a lump-sum investment, usually within one year. These are often purchased near or during retirement.

Deferred Annuities

The investment grows tax-deferred until you begin taking withdrawals, usually years or decades in the future. This allows for accumulation before the distribution phase.

Payout Options

• Life Only: Provides the highest payment amount for a single life but stops at death with no payments to beneficiaries.
• Life with Period Certain: Guarantees payments for life but also ensures payments continue to beneficiaries for a certain period if you die early.
• Joint and Survivor: Continues payments until both you and a designated beneficiary (typically a spouse) have died.
• Period Certain: Provides payments for a specific number of years, regardless of how long you live.

Advantages of Annuities

• Guaranteed Income: Can provide income you can't outlive (with lifetime payment options).
• Tax-Deferred Growth: Investment gains aren't taxed until withdrawn.
• Customizable Options: Various riders and features can be added to meet specific needs.
• No Contribution Limits: Unlike 401(k)s and IRAs, there's no cap on how much you can invest.

Disadvantages of Annuities

• High Fees: Often include mortality and expense charges, administrative fees, investment management fees, and rider costs.
• Surrender Charges: Early withdrawals may incur significant penalties, typically decreasing over a surrender period of 7-10 years.
• Complexity: Some annuities, especially variable ones, can be difficult to understand.
• Less Liquidity: Your money may be tied up for years or decades.
• Tax Treatment: Withdrawals are taxed as ordinary income rather than lower capital gains rates.