Annuity Basics

The time to start planning for your financial security after retirement is now. It’s never too early to start thinking about the lifestyle you want for yourself after you stop working and take tangible steps toward making that vision a reality.

Annuities are a popular way for investors to generate regular income after they’re no longer working. But what exactly are they, and what are the various types of annuities available?

Let’s go over some annuity basics to help you get a better idea of what this form of financial planning is all about.

What is an Annuity?

Annuities are legal contracts between an investor and an insurance company that guarantee a regular stream of payments after a predetermined period. These contracts are most commonly employed to generate income for retirees.

At the start of the contract, the investor makes one lump sum payment or a series of smaller payments to the insurance company. The monetary amount and the number of payments are determined by the contract’s terms and the type of annuity the investor purchases.

After the amount of time designated by the contract has elapsed, the investor receives regular distributions as income. Annuities can carry varying degrees of risk depending on their structure, though most are lower risk than other investments.

3 Common Types of Annuities

While there are many more subcategories of annuity than the ones we’ve listed here, these are three of the most popular and widespread types you’re likely to come across.

1. Fixed Indexed

Fixed-indexed annuities offer a guaranteed minimum payout plus interest based on the performance of a specified market index – the S&P 500, for instance. As the index value increases, so does your interest.

As a protective measure, fixed-indexed contracts stipulate that the interest value will never fall below zero, even when the market does. Likewise, no matter how poorly the market performs, you’ll never lose your already-accrued interest or earnings on a fixed-indexed annuity.

2. Multi-Year Guarantee

Multi-Year Guarantee Annuities (MYGAs) are fixed annuities that pay out a predetermined interest rate over a designated period. The payout period for an MYGA is typically anywhere from three to ten years.

Some investors prefer the stability offered by MYGAs. Since the company issuing the contract must adhere to the timeline and interest amount specified no matter how the market is performing, MYGAs are relatively low-risk investments. They’re also relatively straightforward and do not usually carry fees.

However, MYGAs do not offer a chance for higher returns the way fixed indexed or other types of annuities might. That’s because the interest rate stays constant throughout the entire term of the contract rather than shifting up or down along with the market.

3. Traditional Fixed

Traditional fixed contracts credit interest at a specified annual rate. Each year, the insurance company will review current market conditions and set a new rate for the following year.

Traditional fixed annuities are protected by a minimum guaranteed interest rate. Your insurance company may issue a higher rate, but you’ll never earn interest below that minimum amount.

Since the interest rate, in this case, is determined by the company issuing the contract, it’s wise to research the company extensively before agreeing to sign. Check the company’s renewal rate history if that information is available. Some insurance companies have a predatory habit of enticing clients with higher rates and then lowering them year by year.

The Takeaway

For many older Americans, annuities provide a stable and reliable income stream that gives them peace of mind and financial security after retiring. They can function as a primary source of income or serve as a less volatile supplement to the profits generated by stocks and other higher-risk investments.

Building a fundamental understanding of annuity basics helps you prepare and plan for your future financial security. Remember to discuss all of your retirement planning options, including annuities, with a qualified financial advisor before making any permanent decisions.

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