An annuity is an investment that, over time, makes a number of payments in return for a one-time payment or contributions. You may determine the number of years your investment will create payments at your set return, the principal amount required to generate a specific payment, and the annuity payment that will empty the fund in a given number of years with this annuity calculator.

An annuity is a type of financial agreement that, in return for contributions, provides a stream of income, usually in retirement. Because they can generate cash flow and guarantee that clients never deplete or outlive that income, annuities are a common retirement option.

Insurance firms typically design and sell annuities, which customers can buy by making a lump sum payment or making installment payments over time.

The annuity will pay out over a predetermined period of time, as specified in the contract. The time period may be a fixed period, such as 20 years, or perhaps for the rest of the client’s life. Some annuities may even guarantee a payout for your lifetime and your spouse’s. 

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Annuities can be structured in many different ways depending on the client’s needs, giving a lot of flexibility in creating a setup that works for them. But annuities are not without downsides.

Annuities come in a few different types, defined by their how much they’ll pay out and when. In terms of potential returns, three main types of annuities are:

• Fixed: A fixed annuity guarantees a minimum rate of return on the principal and pays out over a fixed period. 
• Variable: A variable annuity buys into various investments, typically mutual funds. The ultimate return depends on how the investments perform.
• Indexed: An indexed annuity offers a return that tracks an index such as the Standard & Poor’s 500 Index, which holds about five hundred of America’s top companies. 

Annuities can also be defined by when they pay out:

• Deferred annuities pay out at some future point in time, with the client paying into the annuity over a period of time, often over decades of working.
• Immediate payment annuities begin paying as soon as you deposit a lump sum.

General Annuity Information

Annuities, as used in the United States, are contracts for a certain amount of money that are normally paid by an insurance company to an investor in a stream of cash flows over time, primarily as a way to save for retirement. This amount is frequently paid out every year for the investor’s lifetime. In addition to being the policyholder, the investor, also known as the annuity owner, is frequently the annuitant, who is the beneficiary (or beneficiaries) of the annuity whose age and life expectancy are used to establish the terms of the annuity. The owner has the authority to assign the policy, make withdrawals, regulate incidents of ownership in the annuity, and receive the cash surrender value.

Insurance companies that offer annuities pay a specific amount over a predetermined period of time either as an immediate annuity (beginning immediately) or as a deferred annuity (after an accumulation phase). Earnings in annuities grow and compound, tax-deferred, which means that the payment of taxes is reserved for a future time.

Most people use annuities as supplemental investments in combination with other investments such as IRAs, 401(k)s, or other pension plans. Many people find that as they get older, investment options with tax shields approach or reach their contribution limits. As a result, conservative investment options can be sparse, and buying an annuity can be a viable alternative. Annuities can also be helpful for those seeking to diversify their retirement portfolios. The majority of annuity investments are made by investors looking to ensure that they are provided for later in life. In general, annuities make sense for some, but not all. It is important for each individual to evaluate their specific situations or consult professionals.

There are many different types of annuities, including tax-advantaged annuities, fixed or variable rate annuities, annuities that pay out a death benefit to families or last a lifetime, and more. Different annuities serve different purposes, and have pros and cons depending on an individual’s situation.

Pros

• For deferred annuities, similar to 401(k)s or traditional IRAs, there are tax benefits associated with building capital by deferring the payment of taxes.
• Unlike other retirement plans, there is no limit to the amount that can be invested in an annuity.
• Certain annuities can provide guaranteed, predictable income with minimum risk, which can make them attractive to highly conservative investors. For example, a retiree who is more concerned about outliving their assets than receiving the highest returns possible may find annuities appealing.
• Annuities can be used as a regulated stream of income, which can make it easier for a person to manage their assets in a way that ensures that those assets last for the duration of their lifetime. For instance, a heavy spender who suddenly receives a large inheritance can use an annuity to reduce the risk of overspending and depleting their assets.

Cons

• Certain annuity features such as surrender charges implemented by insurance companies, or early withdrawal penalties implemented by the IRS, reduce liquidity. Annuities are not liquid financial assets unless the investor is willing to pay a hefty surrender charge. Investors who are prone to moving money around may want to avoid annuities for this reason. Also, once annuitization begins, marking the transition from contribution to distribution, the action generally can’t be reversed.
• Annuities tend to have complicated tax and withdrawal rules. Each annuity product can have many different rules laid out in their respective contracts, and it is up to each investor to make sure they are operating accordingly and within legal bounds.
• Annuities also have relatively high fees, with some commissions as high as 10%. If there is no commission fee visible on a statement, it may not mean that there is no commission involved in the sale of an annuity; the fee may be hidden in the annuity’s operating costs. On top of that, many annuities (mostly of the variable variety) charge annual fees.
• Annuities normally have low returns. A study of fixed indexed annuities found that their average annualized return rate was 3.27%, which is less than the frequently cited 7% historical return rate of the stock market. This figure generally falls within the ballpark of bond interest rates because insurance companies typically invest up to 70% of their capital in fixed income forms such as corporate bonds. Annuities may not have the higher return rates associated with equities, as observed here, but there is less volatility and risk involved. They sit in a middle category that is below equities but above treasury bills and savings accounts, which generates conservative return rates just above inflation.