What Is an Example of an Annuity?
So you heard the term annuity, but maybe you aren't quite sure what it means. Don’t worry, you’re not alone.
In the most basic sense, annuities are products offered by insurance companies that allow you to add a little more certainty to your retirement planning than you could with traditional investments. There are actually two different categories of annuities: accumulation-focused and income-focused. The first (as you can probably tell from the name) is for saving for a long-term goal like retirement. The second provides reliable income, typically in retirement.
Hopefully it’s starting to make some sense. But perhaps the best way to explain annuities is through examples.
WHAT IS AN EXAMPLE OF AN ANNUITY FOR ACCUMULATION?
When you’re accumulating funds for a goal like retirement there are a couple of examples of annuities.
The first example is a fixed annuity. When you put money into a fixed annuity, you’ll know the interest rate up front and how long you will have to leave your money in the annuity before you can take it out without penalty. If you’re the type of person who would skip to read the last page in the story about your financial life — i.e. you want to know exactly what’s going to happen — then a fixed annuity may be a good choice for you.
Another example of an annuity that can accumulate value over time is a variable annuity. Unlike its fixed cousin, a variable annuity allows you to choose subaccounts for the money that you contribute. The subaccounts typically include a variety of choices, including money-market funds, bond funds, and funds that are tied to market-based investments. This can allow your money to grow more over time than it might in a fixed annuity (although it could also lose value, including the loss of principal). A variable annuity can be an efficient way to take advantage of the growth that market-based investments can provide to accumulate funds that you plan to turn into income in retirement. When looking at a variable annuity it’s important to ask about the cost of guarantees it may offer, as you will pay fees for certainty. Some variable annuities charge high fees for guarantees that you may or may not need. Others have lower fees that can be comparable to the long-term cost of a managed investment account.1
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With an accumulation annuity, you could eventually take your money out and use it for anything you choose.2 Or, you could turn it into an income plan in the future to provide guaranteed income for a certain period of time, as long as you live, or both.
WHAT IS AN EXAMPLE OF AN ANNUITY FOR INCOME?
An annuity for income is a way to guarantee yourself a paycheck for a specified period of time in exchange for an up-front payment to an insurance company. Typically, payments will last for the rest of your life — no matter how long you live. This feature makes an income annuity a great tool for helping reduce the risk of outliving your savings in retirement. Many income annuities also offer what’s known as period certain guarantees. These guarantee that you or a beneficiary will get payments for a minimum number of years even if you die within that timeframe, say 10 or 20 years. The key difference between an accumulation annuity and an income annuity is that with an income annuity, you cannot withdraw the principal you pay in. The money you put in is paid back through the guaranteed payments. Now, let’s a go a little deeper and explore a few different examples of income annuities.
An immediate income annuity starts paying income shortly after you make your payment to the insurance company, typically within a few months. Immediate income annuities are best when you have a sum of money that you’re looking to turn into income right away, usually when you retire.
A deferred income annuity allows you to make a payment to the insurance company today for income that will start arriving at some point in the future, say, several years from now. A few companies also offer an option to earn dividends3, which have the potential to increase your future income that much more. Deferred income annuities are typically best if you’re looking to lock in future income with a sum of money you have today, perhaps your recent investment gains. For example, if you’re in your 50s and would like to lock in a guaranteed income that will start in your 60s when you retire, a deferred income annuity may be a perfect fit. If your income annuity pays dividends, your guaranteed income has the opportunity to grow each year leading up to your retirement — with no extra investment from you.2
Typically, annuities are used as one part of a broader financial plan. If you’d like to consider adding an annuity to your plan, a financial advisor can help you consider your options.
1 See the prospectus for details of all fees and charges.
2 Early withdrawals or distributions from an annuity may be subject to ordinary income tax, a 10 percent IRS early withdrawal penalty if taken before 591/2 as well as contractual withdrawal charges. While several exceptions to the penalty exist, the exception for substantially equal periodic payments is unlikely to apply to Portfolio Income Annuities.
3 Dividends aren’t guaranteed.
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