Financial Resource Center

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At its most basic, an annuity is an investment that later provides a regular income, or payout, to the investor on a set date or series of dates. It is often used as a type of insurance or retirement investment, with regular income for a set period of time or for life, a death benefit, and long-term care benefits.

Beyond this basic description, annuities fall into three categories: fixed, indexed, and variable. A fixed annuity’s payout is guaranteed, while a variable annuity’s payout is based on the performance of the annuity’s underlying investments. An indexed annuity’s payout is determined by a specified equity-based index.

Phases of an Annuity Contract

An annuity contract goes through three distinct phases: accumulation, annuitization, and payout. During accumulation, after the initial payment is made, the annuity total grows and will continue to grow until payouts are scheduled to begin. The investor, called the annuitant, can continue to make payments into the annuity during this phase.

Annuitization is the point at which the accumulation phase ends and the company begins payments to the investor. Once annuitization has been realized, the investor cannot change the terms of payout.

The payout phase is the last and describes how and when the annuity’s income stream is paid to the investor. It will last until the value of the contract is used up or until the death of the investor or their beneficiary, depending on the terms of the contract’s payout method.

Methods of Premium Payment

There are several ways to fund an annuity contract. A single premium can be made as one large lump sum at the start of the contract and fully funds it. A fixed premium means the investor will make equal payments at regular intervals for a specific period of time until the contract is fully funded. Flexible premium payments can vary in amount and regularity, as long as they are above a set minimum amount.

Methods of Payout

There are roughly seven different methods of payout to choose from when selecting an annuity. The core elements that change and mix in a variety of combinations include how long payments are made to the annuitant, what happens with any remaining contract value upon annuitant’s death, and if and how a co-annuitant and/or beneficiary will be paid.

In some cases, the remaining value of an annuity contract goes back to the issuing insurance company. In other payment plans, that value and connected payouts are passed to the co-annuitant or beneficiary. Each payout option comes with pros and cons and should be examined carefully with an investment professional.

There are many more complexities to annuities as investment vehicles for retirement. Fees, taxes, restrictions on benefits, bonuses, and surrender schedules all need to be considered. Like any investment, it can be a wise move at the right time for the right investor. To better understand these complexities, speak with a trusted investment advisor.