This lesson was made possible thanks to Pacific Life Insurance Company
If you look up an “Annuity” in the dictionary, it means “fixed payments”. But when it comes to personal finance and investing, “Annuity” refers to a specific type of investment product that is a common part of retirement portfolios. This lesson is about annuities as an investment product, and why they are used by investors.
What Is An Annuity?
An annuity is simply a contract between an insurance company and an individual or married couple. Depending on the type of annuity, you can purchase one with a portion of your retirement savings in either a single purchase payment or multiple purchase payments over time. Annuities are one of the only financial products you can purchase that allow you to do this through a process called annuitization. The investment part offers the opportunity to potentially grow your purchase payments over time. You’ll pay a fee for the insurance part and investment fees if your annuity includes investment options.
Types of Annuities
Annuities come in two main types – Fixed and Variable.
Fixed Annuities
Fixed annuities are often purchased by those who are close to retirement or uncomfortable with the market’s ups and downs. Fixed annuities protect your principal, or the purchase payments you make, from market downturns, offer a fixed rate of interest for growth, and allow you to turn your assets into guaranteed, fixed payments.
Indexed Annuities
Indexed annuities protect your principal from some or all market downturns, and in exchange may limit your growth potential a bit. They may offer a minimum crediting rate with the potential for additional interest based on the performance of market indices, such as the S&P 500, as well as the ability to turn your assets into income payments. Indexed annuities may be attractive to those who would like to avoid at least some market declines but are looking for more upside potential than a typical fixed annuity.
Variable Annuities
Variable annuities offer the potential to grow your money through a variety of market investments, but also include the potential for market declines. You will have the potential for greater gains, but also for loss, in this case. Variable annuities offer the option to turn your assets into a stream of income payments. They may be attractive to those who are looking for more growth potential than either fixed or fixed index annuities can provide. They also often come with optional benefits that can be added to provide guaranteed growth, guaranteed income, or guaranteed withdrawals for a certain amount of time or for life.
Annuities vs Other Investments
Annuities are considered some of the lowest-risk investments you can make. As an investor who will some day retire, it is important to understand how annuities compare to some of the other types of investments you may have to choose from – since there is often a relationship between “risk and reward”. But as you get older and closer to retirement, having low-risk, consistent-reward assets in your portfolio like Annuities can be a great way to retire with peace-of-mind.