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Analyzing Annuities
Background
An annuity is a type of financial product typically used by retirees looking for a guaranteed income stream. Specifically, it’s a contract between an individual and an insurance company that requires the insurance company to make regular payments to the individual.
Annuities pay out funds while the investor is still alive, unlike a life insurance policy, another insurance contract that is instead paid out after the investor dies (see the differences in this chart). While annuities can protect investors from outliving their retirement savings, life insurance policies protect their beneficiaries in the event of the policyholder’s death.
While people with annuities (annuitants) tend to skew older—most are approaching retirement—some also invest in an annuity contract when they come into a large sum of money, like an inheritance. Lottery winners are also given a choice between receiving a lump sum or going through a lottery partnership with an insurance company to procure an annuity.
How They Work
Annuities have two core phases: the accumulation phase and the annuitization phase.
During the accumulation phase, individuals invest in their annuity with financial contributions. Most annuitants pay into them monthly over many years. The investment grows tax-deferred—meaning it’s not taxed until it’s withdrawn—as it builds up returns. Those gains include interest, but depending on the type of annuity, it can also gain value from market investments made by the insurance company (learn more).
Investments into an annuity are typically locked up during the accumulation period. For one year, most annuitants won’t be able to withdraw any funds. After that, most contracts allow them to take out up to 10% of their accumulated total annually before fees called surrender charges are applied to their withdrawals. Someone who has suddenly come into a lot of cash (such as an inheritance) may choose to invest a large lump sum and skip the accumulation period altogether.
The annuitization phase is when annuities are paid out. Some annuities are structured to pay out monthly for the rest of the annuitant’s life or their spouse’s. Others have a fixed payback period, such as 20 years. Annuity payments can vary greatly depending on the type of annuity and how much money was invested into it—a $100K annuity would pay out from around $525 to $1K per month (see other payment estimates here).
Types of Annuities
Annuities can either be immediate or deferred. Immediate annuities have no accumulation phase and go straight to the annuitization phase, which could be an appealing option for someone who recently came into a large amount of money they want to turn into an immediate income stream.
Deferred annuities, on the other hand, are set up to begin paying out at an agreed-upon date that can be years or decades after an annuitant starts investing in the product.
In addition to being either immediate or deferred, annuities can also differ in how they accumulate value. Fixed annuities guarantee investors no less than a minimum agreed-upon interest rate on all future payouts, while variable annuities can have higher or lower interest rates depending on how the insurance company’s investments fare.
There are also indexed annuities, whose performance is linked to an index like the S&P 500 (it tracks, but doesn’t actually participate in, the market). Their losses are typically limited, and only a portion of the annuity tracks the index to minimize risks.
Learn more about the different types of annuities here.
Pros and Cons
Eight in 10 middle-class annuitants say they bought the contract to provide them with a steady stream of retirement income, and nine in 10 say the contract made them confident in their retirement preparedness.
To protect investors, annuities are regulated at the state level, and certain types (like indexed annuities) are also nationally regulated by the SEC and FINRA. One study found that annuity sales jumped about 23% from 2022 to 2023 as more people looked for lower-risk income streams amid market uncertainty.
Annuities may be less appealing for people who want to keep liquid cash on hand for a large purchase, like buying a house. Early-career professionals who aren’t considering retirement anytime soon often opt for other financial products that provide higher returns.
Background
An annuity is a type of financial product typically used by retirees looking for a guaranteed income stream. Specifically, it’s a contract between an individual and an insurance company that requires the insurance company to make regular payments to the individual.
Annuities pay out funds while the investor is still alive, unlike a life insurance policy, another insurance contract that is instead paid out after the investor dies (see the differences in this chart). While annuities can protect investors from outliving their retirement savings, life insurance policies protect their beneficiaries in the event of the policyholder’s death.
While people with annuities (annuitants) tend to skew older—most are approaching retirement—some also invest in an annuity contract when they come into a large sum of money, like an inheritance. Lottery winners are also given a choice between receiving a lump sum or going through a lottery partnership with an insurance company to procure an annuity.
How They Work
Annuities have two core phases: the accumulation phase and the annuitization phase.
During the accumulation phase, individuals invest in their annuity with financial contributions. Most annuitants pay into them monthly over many years. The investment grows tax-deferred—meaning it’s not taxed until it’s withdrawn—as it builds up returns. Those gains include interest, but depending on the type of annuity, it can also gain value from market investments made by the insurance company (learn more).
Investments into an annuity are typically locked up during the accumulation period. For one year, most annuitants won’t be able to withdraw any funds. After that, most contracts allow them to take out up to 10% of their accumulated total annually before fees called surrender charges are applied to their withdrawals. Someone who has suddenly come into a lot of cash (such as an inheritance) may choose to invest a large lump sum and skip the accumulation period altogether.
The annuitization phase is when annuities are paid out. Some annuities are structured to pay out monthly for the rest of the annuitant’s life or their spouse’s. Others have a fixed payback period, such as 20 years. Annuity payments can vary greatly depending on the type of annuity and how much money was invested into it—a $100K annuity would pay out from around $525 to $1K per month (see other payment estimates here).
Types of Annuities
Annuities can either be immediate or deferred. Immediate annuities have no accumulation phase and go straight to the annuitization phase, which could be an appealing option for someone who recently came into a large amount of money they want to turn into an immediate income stream.
Deferred annuities, on the other hand, are set up to begin paying out at an agreed-upon date that can be years or decades after an annuitant starts investing in the product.
In addition to being either immediate or deferred, annuities can also differ in how they accumulate value. Fixed annuities guarantee investors no less than a minimum agreed-upon interest rate on all future payouts, while variable annuities can have higher or lower interest rates depending on how the insurance company’s investments fare.
There are also indexed annuities, whose performance is linked to an index like the S&P 500 (it tracks, but doesn’t actually participate in, the market). Their losses are typically limited, and only a portion of the annuity tracks the index to minimize risks.
Learn more about the different types of annuities here.
Pros and Cons
Eight in 10 middle-class annuitants say they bought the contract to provide them with a steady stream of retirement income, and nine in 10 say the contract made them confident in their retirement preparedness.
To protect investors, annuities are regulated at the state level, and certain types (like indexed annuities) are also nationally regulated by the SEC and FINRA. One study found that annuity sales jumped about 23% from 2022 to 2023 as more people looked for lower-risk income streams amid market uncertainty.
Annuities may be less appealing for people who want to keep liquid cash on hand for a large purchase, like buying a house. Early-career professionals who aren’t considering retirement anytime soon often opt for other financial products that provide higher returns.
