If you’ve ever looked at the financial products offered through your work or your insurance company, no doubt you’ve encountered the term annuity. You probably, much like myself, wondered what in the world an annuity was and why your insurance company was offering such a product.

What is an annuity

An annuity is a product offered through insurance companies. It is not considered an insurance policy though some type of annuities do share characteristics of life insurance policies. For example there are types of annuities that guarantee your beneficiary receive at least the amount of the original principal investment.

Why purchase an annuity

Annuities are generally used to secure some form of income in retirement. There are many types of annuities. You can choose between an immediate annuity or a deferred annuity, as well as a fixed, indexed or variable annuity.

Should you choose an immediate annuity, you will pay your insurance company a lump sum to purchase the annuity, and the annuity will begin paying you a fixed amount immediately and traditionally, till the end of your life though there are options on the length of time your annuity will pay out.

A deferred annuity has tax benefits and allows you to save more now and get paid back later. When you decide to start getting paid from your deferred annuity, it then starts to behave more like an immediate annuity and you can choose to receive fixed payments regularly.

What separates an annuity from just putting money into a savings account is the investment benefits as well as tax savings you can receive. The money you pay into an annuity isn’t just stuck into an account somewhere but it is invested. With a fixed annuity, the payments to you from your annuity will never drop below a certain amount but because the money you paid in is being invested for you, you can receive more than your fixed payment amount. Typically, your money is invested in bonds and mortgages, safer investments.

Indexed annuities offer some of the same benefits of the fixed annuity such as a garanteed minimum return, but where the fixed annuity payback potential is tied to the performance of bonds and mortgages, an indexed annuities potential is tied to a stock index. When that stock index performs well, your annuity payment amounts increase, bet they can’t drop below the minimum garanteed payment amount you elected when purchasing your annuity.

Variable annuities give you even more control over how your money is invested but the return is not guaranteed so your payments from the annuity could drop below their original amount depending on the performance of the performance of your choice investment, typically index funds.

This is just a taste of what annuities offer and how they work. Annuities may be a viable investment vehicle for you but you should get more information from your insurance company before purchasing an annuity.