What Is An Annuity?

The term "annuity" refers to an insurance contract issued and distributed by financial institutions with the intention of paying out invested funds in a fixed income stream in the future. Investors invest in or purchase annuities with monthly premiums or lump-sum payments. The holding institution issues a stream of payments in the future for a specified period of time or for the remainder of the annuitant's life. Annuities are mainly used for retirement purposes and help individuals address the risk of outliving their savings.

How An Annuity Works

Annuities are designed to provide a steady cash flow for people during their retirement years and to alleviate the fears of outliving their assets. Since these assets may not be enough to sustain their standard of living, some investors may turn to an insurance company or other financial institution to purchase an annuity contract.

As such, these financial products are appropriate for investors, who are referred to as annuitants, who want stable, guaranteed retirement income. Because invested cash is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs to use this financial product.

An annuity goes through several different phases and periods. These are called:

The Accumulation Phase, the period of time when an annuity is being funded and before payouts begin. Any money invested in the annuity grows on a tax-deferred basis during this stage.

The Annuitization Phase, which kicks in once payments commence.

These financial products can be immediate or deferred. Immediate annuities are often purchased by people of any age who have received a large lump sum of money, such as a settlement or lottery win, and who prefer to exchange it for cash flows into the future. Deferred annuities are structured to grow on a tax-deferred basis and provide annuitants with guaranteed income that begins on a date they specify.

Important: Annuities often come with complicated tax considerations, so it's important to understand how they work. As with any other financial product, be sure to consult with a professional before you purchase an annuity contract.

Why You Need An Annuity

Everyone's needs are different. For many investors, particularly retirees, taking risk in the stock market, is just not feasible nor is it acceptable. Annuities are highly customizable, which can allow you to achieve your financial goals in a low-risk and tax-advantaged way. Some of the most significant advantages of annuities include premium protection, income for life, legacy benefits and long-term care optionality.

There are many reasons to buy annuities, depending on your financial situation and lifestyle. One of the most prominent benefits include great growth over time, especially an indexed annuity which is tied to one of many market indices such as the S&P 500 or the Dow. As mentioned previously, your principal is protected by the floor, which is usually set at 0%. So, if you're nearing retirement, and worried about having both great upside potential for gains while having zero risk for loss, you NEED an ANNUITY!