What Are Annuities?

The question that comes to mind when you first hear about adding annuities to your investment portfolio is “what are annuities?” The short answer is that annuities are agreements between two parties in which one party provides a “stream” of payments – a series of payments – to the other party. Because this is usually done on an annual basis, these agreements are called annuities. A more complete answer to the question “what are annuities?” requires an understanding of the variety of products and options available from annuity sellers.

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Life Insurance vs. Annuity

Perhaps it is easier to define an annuity in terms of a product most of us already understand: life insurance. While life insurance protects your beneficiaries by providing them with financial security after you die, annuities are designed to protect you from outliving your savings.

Annuities and life insurance are similar in some ways too. With life insurance, you make monthly premium payments in exchange for a promise from the insurer to provide a pre-defined amount of money to a designated beneficiary upon your death. That amount depends on the level of your monthly payment. With annuities, you make periodic payments to an insurer or other financial institution for a set number of years, and then you receive payouts at the end of that period. The amount you’ve paid over time determines the amount of your annuity payments.

Types of Annuities

There are various kinds of annuities. The plans are categorized by the nature of their underlying investments, the chief purpose of the plan, the type of payout promise, the plan’s tax status, and the arrangement made for payment of premiums.

Underlying investments may be either fixed or variable in nature. The plan’s main purpose may be either deferred, which provides for asset accumulation, or immediate, which provides a payout soon after the plan is purchased. Payouts may be made either over a fixed period of time, as a specified fixed amount, or over the lifetime of the annuity owner. Annuities may be either qualified or nonqualified for tax purposes, and the arrangement for premium payments can be either as a single premium or as a flexible premium. Additionally, a single annuity plan can combine these features to meet individual needs.

Benefits of Annuities

The benefits of annuities include tax-deferred earnings on investments, protection from creditors, a wide choice of investment options, lifetime income, and benefits to your loved ones after your death.

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