Understanding Annuities – A Comprehensive Guide

Do you find annuities confusing? Are you unsure whether they’re right for your retirement plan? You’re not alone. Annuities can be complex financial instruments, but understanding their types, purposes, and investment options is crucial for making informed decisions about your financial future.

Annuities have become increasingly popular, with sales hitting record highs in recent years. More retirees are turning to annuities as a way to secure steady income and ensure they don’t outlive their savings. In this blog post, we’ll break down the fundamentals of annuities, helping you navigate their intricacies and determine if they’re a suitable option for you.

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How can I use an Annuity?

Annuities serve three primary purposes: income, tax-deferral, and growth. These purposes dictate how annuities function and how they can benefit you in retirement.


An annuity can provide a reliable source of income during retirement. This income can be structured in various ways, including through a process called annuitization or living benefits.


One of the key advantages of annuities is their ability to defer taxes on investment gains until withdrawal. This can help maximize your savings by allowing them to grow over time, without having to pay taxes on that growth each year.


Annuities offer the potential for growth through investments. Depending on the type of annuity, your funds may be invested in fixed, variable, or hybrid accounts, each with its own risk and return profile.

What is the difference between an immediate and deferred annuity?

Immediate Annuities

Also known as Single Premium Immediate Annuities (SPIAs), these annuities provide a stream of income payments starting immediately after purchase. It’s somewhat like starting your pension.

Deferred Annuities

Deferred annuities, on the other hand, delay income payments until a later date. These annuities offer more flexibility in terms of when you receive your payments. Most annuities are deferred annuities.

How does my Annuity Make Money?

Once you’ve chosen an annuity type, you’ll need to decide how to invest your funds. Annuities offer several investment options, including fixed, variable, and hybrid accounts.

Fixed Annuities

Similar to a certificate of deposit (CD), fixed annuities offer a guaranteed interest rate for a set period, providing stability and security for your investment.

Variable Annuities

Variable annuities function more like mutual funds, allowing you to invest in a range of assets. However, they come with greater risk and fluctuating returns.

Hybrid (Fixed Index) Annuities

These annuities combine elements of both fixed and variable annuities, offering the potential for growth tied to market performance while providing downside protection.

How do Annuity Surrender Charges Work?

Annuity surrender charges are fees imposed by insurance companies if you withdraw funds from your annuity before a specific time frame, known as the surrender period, has elapsed.

These charges are designed to discourage early withdrawals and ensure that policyholders maintain their investments for a certain length of time. The surrender period typically ranges from five to ten years, although it can vary depending on the specific annuity contract. During this period, surrender charges may apply if you withdraw more than a certain percentage of your account value.

The charges are often calculated as a percentage of the amount withdrawn and decrease gradually over time, eventually reaching zero once the surrender period ends.

It’s important to be aware of these charges and consider them when evaluating the liquidity and flexibility of an annuity investment. Early withdrawals may result in significant financial penalties, so it’s crucial to understand the terms of your annuity contract before deciding to buy an annuity, and before taking money out of an annuity.

How do Annuity Living Benefits Work?

Many annuities come with living benefits designed to enhance their income potential. These benefits may include bonuses, income growth rates, and payout percentages. Understanding how these factors interact is crucial for maximizing your income in retirement.

Annuities with Living Benefits often have two different values to keep track of:

The account value, which grows based on the investment method you chose.

The income value, which is a separate value that is connected to, but different from your account value.

Often, when you hear that an annuity has a bonus or ‘grows at 7%/year’ or ‘pays 5%,’ you are hearing terms related to the income value.  It is the income value that determines how much income you could get out of an annuity.

Here’s an example. Perhaps you put $100,000 into an annuity with a 10% bonus and an income value growing at 7% simple interest. There will also be a payout factor, perhaps 4% below 65 and 5% above 65.

If you buy this hypothetical annuity at age 60 your income value would be:

$110,000 because you got the 10% bonus, and your income number would be $4,400/year because your payout factor is 4% on that $110,000 income value.

The next year your income value would be $117,700 because you got a 7% income value increase, and your new income number would be $4,708.

At 65, 5 years after you bought this hypothetical annuity your income value would be $148,500 and now you would be at an income number of $7,425/year because it’s based on the income value of $148,500 * the new, higher age 65 payout factor of 5%.

Navigating the world of annuities can be daunting, but with a clear understanding of their types, purposes, and investment options, you can make informed decisions about your financial future. Whether you’re seeking reliable income, tax advantages, or investment growth, there’s likely an annuity that aligns with your goals.

Before purchasing an annuity, carefully consider your needs and objectives. Consult with a financial advisor to explore your options and determine the best strategy for achieving your retirement goals. Annuities can be powerful tools for securing your financial future, but it’s essential to approach them with careful consideration and understanding.

Annuity Decision Guide

As your approaching your annuity decision follow this rubric to help make the best choice for you.

  1. What’s your main goal?
    1. Is it Income, Tax-Deferral, or as an Investment?
  2. When do you want money back from the annuity?
    1. Income now is an immediate annuity.
    1. Income later is a deferred annuity.
  3. How do you want your annuity to grow?
    1. Interest Rate growth is a Fixed Annuity.
    1. Market fluctuation growth is a Variable Annuity.
    1. Hybrid approach is a Fixed Indexed Annuity.
  4. Remember, if income is the goal focus on your total income amount.
    1. Not just the bonus that’s advertised.
    1. Not just the income value growth that’s advertised.
    1. Not just the payout rate.
    1. Focus on your total income, which is a combo of those three items.

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