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What Are Annuities?

Jan 12, 2024

Blueprint Income Team

Just because you've retired doesn't mean you no longer need an income. Many wonder if their savings will be enough after they retire, given how small Social Security payments can be. An annuity contract can help you with guaranteed income, tax advantages, and more.

Different types of annuities come with various benefits. Understanding the differences between them is essential.

Definition of annuities

An annuity is a contractual agreement between you and an insurance company to generate income payments over a definite or indefinite period, depending on the annuity. They're investment vehicles that allow you to contribute a lump sum or periodic premiums in exchange for a steady stream of income.

You can also choose when to receive annuity payments, either immediately or at some future date, giving you a unique financial tool that can set you up for regular income payments.

One of the best features of annuities is their ability to provide income for life, similar to pensions or Social Security. If you know that your current pension or Social Security payments won't be enough to cover your costs, an annuity might be a way to supplement your income.

Annuities are different from other investment vehicles in that they aren't speculative. They're designed to be the exact opposite, giving you financial security when you need it most.

Types of annuities

There are different types of annuities designed for people with various financial needs and preferences. Each has its unique advantages. Understanding the differences between them is fundamental to choosing the right annuity to satisfy your retirement goals.

Immediate and deferred annuities

Immediate annuities: Immediate annuities start making payments within a year of initiating the contract. They may suit those about to retire who want a stream of income without waiting. Immediate annuities offer a reliable cash flow and financial security, making them a beneficial investment vehicle for anyone looking to replace an income.

Deferred annuities: Deferred annuities differ from immediate annuities in a couple of key ways. They don't begin disbursing payments immediately, and people often contribute funds gradually, over a longer period. These gradual contributions can come with tax advantages, incentivizing those who aim to supplement their income later in life. Deferred annuities give you more time to grow your investment.

Fixed, variable, and indexed annuities

Fixed annuities: Fixed annuities are one of the most conservative types of annuities, guaranteeing you a fixed rate of return regardless of market conditions. If you're primarily looking for stability in your annuity, this could be the one for you. Fixed annuities also offer security through principal protection, which makes them a good choice for those averse to risk. Variable annuities: Variable annuities are the opposite of fixed annuities, as their value relies on the performance of the underlying investments. The investments may fluctuate based on the market, giving you the potential to increase your annuity disbursements. Variable annuities may better suit those who want the potential to grow their investment and aren't afraid of market exposure and risk of loss. Indexed annuities: Indexed annuities offer a blend of fixed and variable benefits. They tie their returns, in part, to the performance of a market index, giving you both exposure to the market and protection against downturns. You might choose indexed annuities if you're looking for a middle ground between fixed and variable annuities.

How deferred annuities work

Deferred annuities have two distinct phases — the accumulation phase and the annuity phase. These phases entail both the contributions towards an annuity and the eventual, or immediate, disbursement of funds.

The accumulation phase

The accumulation phase is when a person begins making contributions towards their annuity. They can do this through a lump sum payment or by regular contributions. Contributions to an annuity then grow and often receive tax-deferred status. The accumulation phase is when you accumulate your investment until it's ready for disbursement.

You can choose how long you'd like the accumulation phase to last when you initiate the annuity. This gives you flexibility in your contributions and allows you to choose when you want to begin and end your accumulation. Accumulation phases can often last many years, allowing people to adjust their contributions based on their changing financial situation over time.

The annuity phase

You can also choose when to initiate the annuity phase. It can start on a predetermined date, such as when you retire, and marks the beginning of regular payments from the annuity. The accumulated funds will then convert into a steady stream of income that you receive monthly, quarterly, annually, or according to your contract's stipulations.

The type of annuity you choose changes the timing of payments. Immediate annuities will initiate payments within a year of payment. Deferred annuities often provide higher streams of income due to their accumulation phase and overall growth of funds.

Benefits of an annuity

Annuities offer a wide range of advantages that may benefit those heading into retirement. Their predictable streams of income and death benefits added for potential beneficiaries are among their most attractive benefits.

Predictable income stream

Predictable income streams can be hard to come by in retirement, making annuities that much more valuable. They can provide you with a predictable amount regularly that can help you feel secure. Whether you choose to receive an immediate annuity and get a payout right away or a deferred annuity to accumulate wealth over a longer period, the certainty of regular payments is a great help in budgeting and financial planning.

Annuities are also a good way to stop worrying about not having enough money during retirement years. This predictable income stream can ensure a level of financial stability other investment vehicles can't, giving people the ability to enjoy their retirement and rely on their financial security.

Death benefit

Annuity death benefits refer to the financial protection provided to the beneficiaries of an annuity holder in the event of the annuitant's passing. An annuity is a financial product that individuals purchase to receive a stream of income over a specified period, typically in retirement. While the primary purpose of an annuity is to provide a regular income for the annuitant during their lifetime, annuity death benefits ensure that the financial investment made by the annuity holder doesn't go to waste. When the annuitant passes away, the death benefits kick in, offering a predetermined amount or a continuation of payments to the designated beneficiaries. These benefits can vary based on the specific terms and options chosen at the time of annuity purchase, and they provide a measure of financial security for the annuitant's loved ones.

The structure of annuity death benefits often depends on the type of annuity chosen, such as fixed, variable, or indexed annuities. In some cases, the beneficiaries may receive a lump sum payment equivalent to the remaining value of the annuity or a predetermined amount specified in the contract. Alternatively, beneficiaries may have the option to continue receiving regular payments over a set period. The flexibility and terms of annuity death benefits are determined by the annuity contract, and individuals are encouraged to carefully review and understand these terms when selecting an annuity to ensure that the chosen product aligns with their financial goals and the needs of their beneficiaries.

The downsides of annuities

While annuities offer several benefits, they also have some drawbacks. Some of the more notable downsides of annuities can be their higher fees and surrender charges.

Higher fees

Some annuities have relatively higher fees compared with other investment options. These fees may be for administration and investment management. They can accumulate and impact your overall return. Blueprint Income earns commissions from the sale of annuity products. Commission rates are typically set by the insurance companies and are already factored into the interest rate quoted, so you're not paying any extra to work with us.

Surrender charges

Another potential downside to an annuity is its surrender charges or penalties for withdrawing your funds too early. The surrender period is the time in which you can't withdraw more than a specified amount from your annuity without penalty. This period is set when you make the contract so ensure the terms work for your financial situation and you won't have to withdraw from your annuity before the term is up.

While annual contract fees may be an unwelcome expense, surrender charges are substantial in their own right. However, they're designed to prevent annuitants from premature withdrawals and early contract terminations. They can also eat away at your investment, potentially diminishing your returns substantially. 

Deciding if an annuity is right for you

Deciding whether an annuity is right for you requires consideration of your retirement goals. While they have several advantages, such as their ability to provide a predictable income stream and death benefits, they also come with potential downsides. 

Existing income sources such as a pension or Social Security disbursements may also influence your decision. If your current income sources are insufficient, or you're about to retire and aren't confident they can support you, an annuity may be a good way to supplement your income. 

Different types of annuities also come with unique benefits. Fixed annuities offer stability, while variable annuities provide the potential for higher returns. Indexed annuities sit between their fixed and variable counterparts, offering stability with a hint of market exposure.


Blueprint Income Team

We are a team of finance, insurance, and actuarial professionals working to make it easier for everyone to achieve a steady and comfortable retirement. We write about annuities (the good and the bad) and provide strategies to help Americans prepare for retirement.

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