How Do Annuities Work?

Many people want to set themselves or their family members up to have an income for life that cannot be taken away. One of the ways that they do that is by setting up an annuity. An annuity is a periodic payment that you either receive or that you pay into.

A couple of things you likely pay now are your mortgage and insurance payments, both of which are considered annuities. When you get a monthly payment from an investment program, that can also be considered an annuity, and that is the type we are talking about here. The main thing to understand is that to be an annuity, there needs to be set payments regularly.

Buying an Annuity

You can either make a lump sum payment to your insurance company, or you can pay a down payment and then add to the principal every month. Depending upon the type of annuity, the insurance company may invest it safely. Whenever you see the words “safe” and “investments”, you can assume a low return. However, for the low return, you get an income for life or for the term of your contract.

Collecting the Payments

Once you decide to retire per the contract, you will then change the plan from its growth period or “accumulation period” into the payment or “amortization period.” You can get those payments for life or the term of the contract, and you can also assign a beneficiary to your annuity in the case of your death.

Types of Annuities

There are three types of annuities: fixed, variable, and indexed. A fixed annuity guarantees that you’re going to receive a set amount of interest and a set guaranteed payout either for life or for the term you set for the annuity. A variable annuity lets you choose a higher risk level if you want so that you can get better payouts. Having said that, you can also lose money. An indexed annuity sets your return to the market index (S&P 500). If your fund does well, you can earn more, but there is more of a risk too.

When You Get Payments

Getting your payments depends on whether you purchased an immediate annuity or a deferred annuity. The immediate annuity can give you a monthly income right now, while keeping your money in a safe place and helping you budget. The deferred annuity is one in which you start collecting payments later in life.

As you can see, while it appears complicated, an annuity is a safer form of investing money to help ensure you an income for life. Plus, you may also be able to ensure your spouse’s income for life too even if you die. But remember, you’ll be penalized for taking any cash out of the account, so you need to make sure that you have emergency savings to access elsewhere and not just the cash in your annuity.

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