Annuities - The Basics

Annuity – What is an Annuity?

In its simplest definition, an annuity is an amount that is payable annually.  More specifically, an annuity describes a contract offered by insurance companies that allows you to accumulate funds for retirement on a tax-favored basis, and then receive an income that can be guaranteed to last as long as you live.

An annuity is neither a life insurance nor a health insurance policy.  It is not a savings account or a savings certificate.  You should not buy an annuity to reach short-term financial goals.  An annuity is a retirement planning tool.  Your value in an annuity contract equals the premiums you have paid, less any applicable charges, plus interest credited.  The insurance company uses the value to figure the amount of most of the benefits that you can choose to receive from any annuity contract.

Annuities have several benefits including: providing tax deferred income, avoidance of probate (meaning the proceeds of the annuity can be passed directly to your beneficiary at the time of your death), providing you with a guaranteed income stream for live, and offering a variety of annuity types and payout options.  However, annuities present complex issues regarding taxes, fees, and withdrawal strategies that may not make them the best investment choice for you. Consider discussing this type of investment first with a financial planner and your tax advisor.

Annuities – How do they work?

An annuity is a vehicle for accumulating retirement savings in that you pay a premium to an insurance company and they promise to pay you interest.  An annuity has two parts or periods:


During the accumulation period, the money you put into the annuity, less any applicable charges, earns interest.  Unlike other retirement savings instruments, the earnings that occur during the term of the annuity are tax- deferred.  You are not taxed on them until they are paid out.  Because of the tax deferral, your funds have the chance to grow more quickly than they would in a taxable investment.

During the second period, called the payout period, the company pays income to you or to someone you choose.  Again, unlike other retirement savings instruments you will have the option as to how you receive your funds, i.e. you can choose to receive a guaranteed income for as long as you live.

How do annuities best serve investors?

The two primary reasons to use an annuity as an investment vehicle are:

  1. You want to save money for a long-range goal (like retirement)
  2. You want a guaranteed stream of income for a certain period of time.

The rest of this guide will focus on the understanding how annuities works, the various types that exist and what role annuities should play in your financial plans.