What Are Annuities?

What Are Annuities?

August 24, 2023

An annuity is a financial product or contract that involves a series of regular payments made over a specified period of time. These payments are typically made by an individual or entity, often referred to as the "annuitant" or "policyholder," to an insurance company or financial institution. In return, the annuitant receives a stream of income from the annuity.

There are several key characteristics and types of annuities:

  1. Payment Structure: Annuities can be funded through a lump-sum payment or a series of payments. The series of payments can be made either during the accumulation phase (when the annuitant is contributing to the annuity) or the distribution phase (when the annuitant starts receiving payments).

  2. Distribution Phase: During the distribution phase, an annuity provides a regular stream of income to the annuitant. This can be in the form of fixed payments or variable payments, which can fluctuate based on the performance of underlying investments.

  3. Types of Annuities:

    • Fixed Annuities: These provide a guaranteed, fixed rate of return on the invested funds. They offer stable, predictable payments.
    • Variable Annuities: With these, the annuitant can invest in a selection of underlying investment options (such as stocks, bonds, or mutual funds). The payments can vary based on the performance of these investments, and there is a potential for higher returns, but also higher risk.
    • Indexed Annuities: These combine features of both fixed and variable annuities. The return is linked to a specific market index, offering the potential for higher returns than a fixed annuity, while also providing some level of protection against market downturns.
    • Immediate Annuities: The annuitant starts receiving payments shortly after making a lump-sum payment. These are often used by retirees looking for a regular income stream.
    • Deferred Annuities: Payments start at a future date, allowing the annuitant to accumulate funds and potentially benefit from compound interest.
  4. Tax Treatment: Annuities can have different tax implications based on whether they're funded with pre-tax or after-tax dollars. Earnings within an annuity typically grow tax-deferred until withdrawals are made, at which point they may be subject to income tax.

  5. Guarantees: Some annuities offer various guarantees, such as minimum returns or minimum income payments. These can provide additional financial security to the annuitant.

Annuities can be complex financial instruments, and it's important to fully understand their terms, fees, and potential benefits before purchasing one. They can serve as retirement income solutions, but they may not be suitable for everyone's financial situation. If you have questions about annuities and want to know if they fit as part of your overall financial plan, please give the team at Arrowhead Wealth Partners a call!

Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.