What is an Annuity?

Have you ever been intimidated by all of the different types of investments that are offered today? There are bonds, stocks, index funds, money market accounts, mutual funds, growth stocks, foreign currency markets, CDs, annuities, and the list goes on and on. There’s no wonder why the average person shies away from the complexities of investing! In reality though, each of these terms can be broken down and easily understood by just about anyone. The same is true for annuities.

When Would One Invest In an Annuity?

If you’re under 50 years old, I would suspect that no financial advisor has ever suggested an annuity to you, and for good reason. Typically, annuities are for those that plan to retire soon because it provides them with a consistent income over a designated period of time, or on occasion, for life! But, before I get too far ahead of myself, let’s dig into the basics.

In most instances, annuities are useful for those that have a large sum of money, but wish to have a consistent income for the rest of their lives. Something similar to if they were still working – a paycheck if you will. In order to receive these consistent funds, the individual must first invest a lump sum of money into an annuity account (this money is typically from their 401(k) or IRA funds that have been compounding for many years). The “paycheck” amount is then dependent on the lump sum that was deposited and the annuity rate that is set on the fund.

Fixed vs. Variable

So what are annuity rates? That answer is fairly simple as well. Imagine you were buying a Certificate of Deposit. Say you put in $1,000 and the rate on the CD is 3%. At the end of the term, you’d receive your thousand bucks, plus you’d receive an additional $30 (your 3% return). An annuity rate is very similar. It’s just the rate that is offered on your lump sum, which is then distributed to you through your received payments.

With annuities though, you most likely have two options. You can choose a fixed annuity or a variable annuity. The fixed annuity just means that you’re locked into the rate. If the annuity rate is 2% at the time, then that’s what you’ll receive for the life of your annuity. A variable rate, however, is just as it says, variable. The rate will move up and down, depending on the annuity market. Sometimes you might receive a higher payment because the rate is more, but at other times, your check may be for less. If you anticipate that the rates will increase in the future, then perhaps a variable rate is the best option. Take a look at the history of annuity rates and make an educated decision.

What is an Annuity?

Sweating the Big Stuff

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