Retirement Basics: How Annuities Work

About 38% of American households have an annuity or pension that provides them a steady income in retirement. Yet, despite this, most Americans don’t know what they can spend each month without running out of money.

If you have an annuity, it’s crucial that you understand how annuities work. That way, you can make smart financial decisions about the management of your annuity.

This guide will help you understand what your annuity is and how it works.

What Is an Annuity?

The annuity definition explains that this is a financial tool that can be a valuable addition to your retirement plan. An annuity is an insurance product that pays you an income. The amount of the monthly payment depends on the growth rate and length of the payment period.

Annuity Types

There are four basic types of annuities; immediate variable, immediate fixed, deferred fixed, and deferred variable. The different types are defined by how the annuity grows and when you want to start receiving payments.

Immediate annuities mean you start receiving payments right away. Deferred means you will start receiving the payments at some point in the future.

Fixed annuities have a set interest rate that your annuity will grow at. Variable annuities invest your contributions in the market. This gives you great risk but also the chance for greater reward.

Annuity Phases

There are two phases for annuities. The accumulation phase is the period after purchase but before payments start. As a result, you’ll enjoy a minimum growth rate and tax-deferred growth. The second phase is the annuitization phase that signals the commencement of payments.

How Do Annuities Work When You Retire?

There are two common terms that you will hear when talking about annuities. Retirement annuities supplement your retirement savings and Social Security checks.

Life annuities can provide you with a guaranteed income for the rest of your life. This type of annuity is nice because you never have to worry about running out of money in retirement. You might hear them called a joint and survivor annuity.

These provide payments to spouses for as long as they live. So as long as one spouse is alive, the annuity will continue to make payments.

Cash Refund Option

You will receive your payments as planned upon with this option. However, if you pass away before receiving your full principal back, then the difference goes to your chosen beneficiary.

Limits on Life Payments

Choose a beneficiary that will receive payments should you pass away before a chosen time period. The beneficiary will then continue to receive payments for your chosen number of years. If you live beyond the chosen threshold date, then you will continue to receive payments for the rest of your life.

You Know How Annuities Work

Now that you understand how annuities work, you are ready to purchase your own. This can be a valuable part of your retirement plan. If you don’t need the money right away, you can delay payments and let your annuity accumulate in value.

Check out our other articles for more helpful financial advice.


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