An annuity is a type of retirement income investment that allows you to receive periodic payments for the remainder of your life beginning at a predetermined time. Investors can choose from a variety of annuities, such as fixed, indexed and short-term annuities. You buy an annuity from an insurance company. Depending on the type of annuity you establish, you invest a lump sum amount or make payments over time to the insurance company, which become your principal balance. The funds are invested in financial securities by the insurance company according to your annuity type.
Fixed annuities offer investors a guaranteed return on their principal and a fixed rate of return. You receive fixed payment amounts from the insurance company at predetermined times outlined in the annuity contract. Payments can last for a definite or indefinite period. Many investors favor fixed annuities because they know at the time of purchase the exact amount of money they will receive at retirement. Investors who are conservative and do not desire to place their money in the stock market typically choose to purchase fixed annuities over other types of annuities. You can take your money out of a fixed annuity, but must pay income tax on taxable amounts, and may have to pay withdrawal charges and an income tax penalty.
Indexed annuities are more complex than fixed annuities. The value of an indexed annuity is contingent upon the performance of a specific equity-based index, such as the S&P 500. The return on an indexed annuity fluctuates more than a fixed annuity, but not as much as a variable annuity. An indexed annuity comes with a guaranteed minimum return. Unlike a fixed annuity, the entire principal is not guaranteed. According to the Financial Industry Regulatory Authority, life insurance companies typically offer a guaranteed minimum return of 87.5 percent.
A short-term annuity is commonly referred to as an immediate annuity. Unlike a fixed or indexed annuity, a short-term annuity allows you to begin receiving income payments one period after you make your initial lump sum deposit. Your deposit is invested in conservative assets. Many individuals nearing retirement age choose immediate annuities because there is no accumulation period. When you receive income payments, a portion of it is taxable. Immediate annuities are illiquid assets. You must keep your money in the annuity once you make the initial investment, and funds do not go to your heirs if you die.
As with other investments, you should consider the features of different types of annuities before making an investment decision. Annuities are not insured by the Federal Deposit Insurance Corporation, so you are always at risk of losing money. You should also understand how the insurance company plans to invest your money, and all fees associated with the annuity. Consider your financial goals and risk tolerance when deciding on the right type of annuity to invest in for retirement..