The Basics of Annuities

When planning for your retirement and future, you have several options to help secure your financial situation. There are traditional IRAs, Roth IRAs, 401(k)s, Social Security and even annuities. Investing in annuities can actually help you supplement other income once you reach retirement age.

An annuity is a contract between you and an insurance company. You pay the insurance company a certain amount of money, and they agree to make payments to you – either in one lump sum or in smaller payments over a period of time. The insurance company will invest your money so that it grows before or as you’re being paid back.

One of the major benefits of investing in an annuity is what is called tax-deferred growth. Your investment will grow by earning interest but isn’t taxed as it earns money. The money is not taxed until it is used or paid out.

There are two main types of annuities you can invest in. The first time is the fixed annuity. With a fixed annuity, you agree to pay the insurance company a specific amount of money and the insurance company guarantees a specific rate of return on your investment. Then when the time comes for the insurance company to being making payments to you, you know exactly how much the payments will be each time. You can set up how long you want to receive payments – whether it’s for a specific number of years or until the death of you and/or your spouse.

A variable annuity starts out the same way a fixed annuity does. You pay an insurance company a dollar amount, or you make can payments, and the insurance company agrees to pay you over a period of time. First when you make payments or a lump sum payment, this is called the accumulation phase. The money you pay during the accumulation phase is invested in mutual funds or other investment options. Therefore the value of your annuity account is tied to the return of your investment in these investment options.

As your money grows, it isn’t taxed by the government. Then once you receive payments, that money is subject to being taxed. After you start receive payments from the annuity, this is called the payout phase.

Because the amount of money you earn from your investment is tied to mutual funds or other investments, you’ll want to research these options to help make sure your investment will grow. You’ll also want to make sure you research various insurance companies to make sure you find a strong company that will stay in business. If an insurance company goes out of business, it may default on your annuity. Though there are ways to insure your investment – usually up to $100,000.

If you die before your variable annuity has been paid out, there is death benefit. This means that your spouse will receive a certain amount of money upon your death – at least up to the amount that you first invested in the annuity.

Along the same lines as the variable annuity are equity-indexed annuities. These annuities are tied market indices, the S&P 500 Composite Stock Index for example. The insurance company you buy the annuity from will usually guarantee a specific rate of return on your annuity; but if the market index the annuity is tied to performs well, you can increase your rate of return.

Be sure to check with your insurance company about the details and differences between fixed annuities, variable annuities and equity-indexed annuities. Sometimes the terms and conditions can be complicated – and you’ll want to make sure you are aware of all fees associated with your annuity and the best way to get the highest rate of return on your investment.