The Basics
An annuity is a product that is marketed by an insurance company. It combines some features of life insurance with some features of investment products. This allows them to provide some benefits of both. A good product should be a safe investment with guaranteed returns, but also provide the owner with higher returns than some other savings options.
Fixed vs Variable
I am writing about fixed annuities only. You may have heard about variable annuities, but they are beyond this article. They are for a more risk adverse investor, and beyond the scope of what we are discussing.
People like fixed annuities because of their safety. They are intended to help the owner reach a future financial goal. Common examples are retirement savings or a college education fund.
Most people think about having a guaranteed payout after a period of years from their investment, but a person can choose different types of payouts too.
Returns are earned in different ways, but it is common to see set interest rates or having the return pegged to some large market index. The S&P 500 is one example of this. With an indexed fund, the return will rise as the stocks go up.
Of course a major selling point of fixed annuity products are guarantees that they will not lose money during down years. Some may have a guaranteed return of 2%, or even 0%. This is better than a negative return rate. Make sure you understand the return guarantee of the annuity you are considering.
If you invest in stocks or mutual funds, you know you are taking a risk. You can lose money. While your annuity fund may not earn quite market rates during good years, it should not lose money during downturns in the market. Everybody who has been keeping up with recent financial news knows how important this can be, especially when you are saving for retirement.
One other big point in favor of this type of product is favorable tax treatment from the IRS. The cash, and compounding, can grow tax deferred. And depending upon the IRS status of the fund, payments may also get a better tax treatment than some other types of investments.
You need to find the right product for you.
The amount of time you can do without your money, how long you want to get paid, and home much income you need to generate are a few of the things to weigh. One product will not provide the best solution for everybody, but there are many choices on the market these days.
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