What Is The Definition Of An Annuity?



The definition of an annuity is a financial product that gives a fixed stream of payments to people. This fixed stream is mostly used by those people who have got their retirement from the office. In simpler words, an annuity is a contract that a person signs with an insurance company to get long-term payments and benefits from it. Most people who are getting retired do such kind of investment to get a constant payment to support their living even after retirement and live a happy life.

Moreover, the investors can decide the date when they want to start their annuity payouts. They can select the date and once that date arrives, they can start getting their payouts. They help individuals address the risk of outliving their savings. Upon annuitization, the holding institution will issue a stream of payments at a later point in time.

There are two phases in the annuity. One phase is known as the accumulation phase in which the funds are added to the annuity, while the other is the annuitization phase in which the payments are commenced. Going more deeper into the annuity concept; it can be divided into different structures, such as fixed, variable, immediate, and deferred income.

How do Annuities work?

The working of annuity is simple and easy to understand. For example, if you are an investor you will put a lump sum amount in a bank account and will keep on adding that amount into that account until you want. Once you get to retire from your job you can start getting that amount in the form of constant or variable payouts. The annuities act more than just a social security program, they can fund your whole living style after your retirement.

However, you can start even before your retirement, all depends on when you want to start. You basically mention that date in your contract when you want the contract to begin which makes things easier for everyone. Once the annuities are being paid, they will keep on generating until you or your beneficiary is alive.

In essence, when you buy a deferred annuity, you pay a premium to the insurance company. That initial investment will grow tax-deferred throughout the accumulation phase, typically anywhere from ten to 30 years, depending on the terms of the contract. Once the distribution phase begins based on the terms of the contract, you will start receiving regular payments.

Definition of an Annuity
Definition of an Annuity


Types of Annuities

There are different types of Annuities and people can choose according to their requirements. Moreover, the personal goals and objectives decide the type of annuity that a person would choose. Let’s have a look at different annuities.

Fixed Annuities

These annuities come with a fixed flow of income and a fixed flow of rate of interest. Moreover, they also follow a strict timeline during which you can withdraw your money from your annuity. These kinds of annuities are backed by banks and insurance companies.

Fixed annuities are lower risk than variable annuities, which determine interest rates depending on the performance of the underlying investments. They are simple and straight-forward and can provide the most predictable and reliable income stream with low fees.

Fixed Indexed Annuities

These are just like fixed annuities with a little twist. These annuities basically attach stock with your investment. However, there is no risk in it. Even if the stock goes down you will receive a minimum amount of sum from the company. However, if the stock did well, then you can get a better amount of money that month from the insurance company.

Variable Annuities

This definition of an annuity is all about profit and gain. You will not receive any minimum payment even if your stock did not perform. That means you are at risk. But this kind of annuity is great for those people who have side business even after their retirement and they can fall back onto their business if the stocks did not do well in that particular month.

However, if it has performs well, then you will get more than just the mere interest value. Just like Fixed Indexed Annuities, it is also tied with the stock values or interests.

Why you should go for buying an Annuity?

There are multiple reasons for this because this is a long-term project which can help you in fulfilling your need once get old and get retirement from your job. But let’s have a look at the most important reasons.

  • Tax-deferred growth.
  • Principal Protection
  • Inflation Adjustment
  • Death Benefits for heirs
  • Long-term Security
  • Probate-free estate distribution

Buying and Selling of Annuities

Insurance companies, banks, brokerage firms, and mutual fund companies sell annuities and you can buy them from them. But, always remember, read all the requirements what they are saying the contract. You must make it clear for the companies to specify all the fees in the contract.

Read magazines as much as you can to understand and to get timely information about the annuity. For that, you can check the mutual fund’s prospectus. Request prospectuses for all the mutual fund options you might want to select. Read the prospectuses carefully before you decide how to allocate your purchase payments among the investment options.

Let me tell you about called surrender charges. These charges come when you withdraw your money before time or you want to pull out of the whole annuity deal. The insurance company then charges you with a fee known as surrender charges. So, always have a clear mind before withdrawing any annuity.

Benefits of Annuity

The benefits are huge if you ask a person who is getting retired and does not worry about the income. He is going to get his income from the annuity that he has been paying for quite some time.

Secondly, they do not have any kind of contribution limits. Moreover, it creates a stream of predictable income stream to fund retirement. With an annuity, you don’t have to worry about outliving your savings. This is a major advantage in the post-pension age.

Disadvantage of Annuities

Usually, everything comes with some negative aspects. Like eating sugar-products will end your craving but will also make you fat. The same is the case with annuities it also has some disadvantages.

Basically, some consumers feel that sacrificing liquidity in return for lifetime financial security is a disadvantage. This is understandable for such cases where people are low on cash in hand and for the annuity is not the right option. It wouldn’t make financial sense to purchase a valuable, viable product if it’s not valuable and viable for you.