How Do Annuities Work?

What Are Annuities? 

Annuities have become a very attractive financial product these days? And even though many people have been advised to look into these products by their bankers or financial experts, most consumers do not understand them. Let’s go over the basics of how annuities work.

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What Are Annuities?

Annuities are products from life insurance companies, and they combine features of both insurance policies and investment products. They are usually used to save for long term goals, or to provide income for a period of time. But because of the favored treatment of life insurance products by the IRS, they can also have tax advantages over other savings products.

Fixed Annuities can provide a guaranteed return, or they can be pegged to a market index like the S&P 500. Even though they follow the market index, they can have a guarantee that the owner will not lose money during a market downturn. Over a period of years, this can be combined with tax savings to produce good and secure returns.

So for instance, say a fixed, index annuity follows the market, but has a guaranteed return of 2%. During 5  years of growth, the return could be 6% (still better than bank CDs, plus tax deferred growth), and during 2 down years, the annuity still returns 2%. If you look at the average return, it is still better than many other savings vehicles, plus the growth gets a favorable tax treatment!

An immediate annuity accepts a lump sum as payment, and then starts to provide an immediate income. These are popular with retireees who need to transfer retirement money in exchange for monthly or yearly payments. Deferred annuities can be part of a long term savings goal because contributions can be made over a period of time, and then the owner can take advantage of accumulated income.

Learn more about annuities: Explain Annuities

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