With an annuity, you make an upfront payment in return for regular payments in the future.
Annuities pay out in a way that is similar to other well-known retirement vehicles like pensions and Social Security.
An annuity is typically part of a larger financial plan; a Northwestern Mutual financial advisor can show you how an annuity can strengthen your financial plan.
So you’ve heard the term annuity, but you may be wondering what an annuity is. 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. Essentially, it’s a financial product that can guarantee payments in the future.
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?
There are a few different examples of annuities that can help you accumulate funds for a goal like retirement. Here’s how they work.
How fixed annuities accumulate wealth
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. As interest rates rise, annuities may also begin to make more and more sense as you plan your future.
How variable annuities accumulate wealth
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
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 premium contribution(s) you pay in. The money you put in is paid back through the guaranteed payments. Now, let’s go a little deeper and explore a few different examples of income annuities.
How immediate income annuities make money
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. They can also be beneficial in retirement because often—if you live long enough—immediate income annuities should pay out more than you pay in over time.
How deferred income annuities make money
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. And like an immediate income annuity, you have the potential to receive more than you pay in as the annuity pays out over time.
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.3
What else might qualify as an example of an annuity?
There are a number of arrangements that are associated with annuities and even referred to as annuities. Though they may have similarities to annuities, the reality is: they really aren’t technically income annuities such as those offered by insurance companies
Can lotteries be examples of annuities?
Annuities are sometimes mentioned in the context of lotteries. That’s because for large jackpots, winners have the option to take a lump sum (which is less that the advertised jackpot) or to take payments over time. The payments over time are technically an annuity. There are a number of factors that would go into the decision about whether to take the smaller lump sum all at once or the annuity over time.
Is a pension an example of an annuity?
A pension bears a lot of similarities to an annuity; when you retire and receive a pension, you’ll often receive an income (in the form of regular monthly payments for life. There are some key differences between a pension and an annuity; however, so it’s not technically an example of an annuity through an insurance company
Are retirement plans examples of annuities?
An annuity is a financial product, whereas a retirement plan is usually a combination of investments and savings accounts. So, a retirement plan itself doesn’t technically qualify as an annuity, though an annuity may be included as part of a retirement plan. You may supplement retirement savings with an annuity, convert retirement funds from a 401(k) or IRA into an annuity or even hold an annuity in your 401(k) or IRA. A Northwestern Mutual financial advisor can help you look at all of your assets and financial goals to build a broader, well-balanced plan that relies on multiple financial products—including annuities.
Is Social Security an example of an annuity?
Social Security is not an annuity, however, when it comes to the way the payments work it does have some similarities to an annuity. The common thread between Social Security and an annuity are the regular payments that last throughout your life.
What’s an example of an annuity fund?
An annuity fund can be any type of sub account in a variable annuity the client directs the issuing company to allocate premiums into, to grow (or lose) value over time and ultimately provide income payments at a future date, such as during retirement. These funds could be backed by stocks, bonds or other types of investments.
A financial advisor can share examples of annuities
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 Northwestern Mutual financial advisor can help you learn about the products Northwestern Mutual has to offer and consider which option best fits your situation.
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.