What Is an Annuity, and Why It Could Be a Key Piece of Your Retirement Plan?
Retirement planning has many moving parts. You have investments, Social Security, savings, and the uncertainty of how long your money needs to last. Annuities often sit somewhere around the edges of those conversations, familiar by name, but elusive in meaning. In this article, we’ll demystify annuities in plain language: what they are, how they work, and when they might be able to help you secure your future.
Annuities in Simple Terms
At the core, an annuity is a contract between you and an insurance company. You pay in a lump sum or periodic premiums over time. In return, the insurer pays you a stream of income under terms you agree upon. That income can begin right away (immediate annuity) or at some point in the future (deferred annuity).
The idea is to convert a portion of your savings into steady income, much like a personal pension, so you don’t have to rely purely on market returns or spending down your principal.
The Two Key Phases: Accumulation and Distribution
Annuities generally operate in two distinct phases:
Accumulation Phase
This is when you make contributions, either a lump sum or periodic payments, into the annuity. The money grows (often tax-deferred) during this phase. How your money grows depends on the type of annuity (which we’ll explore later).
Distribution (or Income) Phase
At your selected time, the annuity begins paying you. These payments can run for a fixed duration or for the rest of your life. Some annuities allow for flexible payouts, others lock in ones that cannot be changed once started.
Why People Use Annuities
Here are some of the benefits that make annuities appealing, particularly when used thoughtfully:
- Predictable income: Knowing a portion of your expenses is covered, no matter what the markets do, brings peace of mind.
- Longevity protection: You don’t want to outlive your money. Annuities guard against that risk by offering payments as long as you live.
- Tax deferral: Earnings within the annuity often grow without being taxed until you withdraw them.
- Flexibility through riders: Many annuities offer optional add-ons (riders) for features like inflation protection, guaranteed minimum income, and death benefits.
Of course, these advantages depend heavily on the specific annuity, the provider, and your own financial situation.
Not All Annuities Are the Same
One of the biggest misunderstandings is thinking “annuity” is a single product. It’s not. Here are a few major types:
- Fixed annuity: Offers a guaranteed interest rate and predictable income.
- Variable annuity: Lets you invest in subaccounts (like mutual funds). Your payments depend on performance.
- Indexed annuity: Ties earnings to index performance (like S&P 500), usually with caps or participation rates.
- Immediate annuity: You begin receiving payments almost right away.
- Deferred annuity: You wait some time before income begins, giving your money time to grow first.
Each type has tradeoffs. Some offer more growth potential but more risk. Others favor guarantees but limit upside.
When an Annuity Might Make Sense, and When It Might Not
Annuities are not for everyone, but they can be a powerful tool in the right circumstances.
If you are someone who values certainty in your income, wants to reduce reliance on volatile markets, or is concerned about running out of money, then an annuity might help.
On the other hand, if liquidity is critical (i.e., you may need to access your money freely), or you already have income sources that cover your essential expenses, an annuity might not be the best fit.
The decision should always align with your goals, timeline, and willingness to trade flexibility for stability.
What to Ask Before You Sign
Before committing, here are a few things to understand clearly:
- What fees or costs are associated?
- What is the financial strength and reputation of the insurance company?
- Are there surrender charges if you withdraw early?
- Can you add riders (inflation, long term care benefit, death benefit, etc.), and at what cost?
- When do payments begin, and can they change?
Taking time to ask and understand gives you confidence in your choice.
If you’d like to explore whether an annuity makes sense in your retirement plan, contact Troy for a no-pressure conversation. He’ll walk you through how an annuity might fit your goals and help you make an informed decision.
Disclosure: This information is for educational purposes only and is not intended as a recommendation to purchase or sell any annuity or other product. Products involve risks, fees, and surrender charges that may not be suitable for all investors. Guarantees are subject to the claims-paying ability of the issuing insurance company