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What is an Annuity? How an Income Stream Can Help You in Retirement

The annuity remains a great option for retirement income, even in the face of rising inflation rates and an uncertain market. Many people may be asking whether their retirement savings will survive today’s market volatility. While certain types of annuities can protect clients against rapid market changes, they are sometimes left out of the conversation because they lack mainstream exposure and can be hard to understand. Which is why, for Annuity Awareness Month, we would like to answer the evergreen question: What exactly is an annuity?

The Annuity, Explained

In simplest terms, an annuity is a financial product which acts as an accumulation vehicle. Annuities can protect clients from outliving their assets by providing steady cash flow during retirement.

They operate a bit like life insurance: clients choose to put money into a policy which, at a certain point, is paid back with accumulated interest. While life insurance is more or less paid after the owner’s death, annuities are paid at the owner’s retirement to guarantee an income for their retired life.

Annuities have two distinct phases: the accumulation phase, when the client funds the annuity, and the distribution phase, when the payments to the client begin. Because the annuity’s purpose is to fund retirement, they are considered illiquid vehicles, meaning the funds cannot be withdrawn early without a hefty surrender charge or fee.

One confusing aspect is that there are different types of annuities based on how they accumulate and distribute, with different features that can support various lifestyles. In general, there are two main accumulation types (fixed or variable) and two main distribution types (immediate or deferred) for annuities.

Fixed and Variable Accumulations

The accumulation phase relates to how the policy grows its funds. Fixed annuities are not tied to the stock market, and therefore they have a fixed interest rate. A variable annuity is based on stock market performance, giving the owner the chance to receive bigger payments if their investments do well — the cash flow is less stable, but it allows for better rewards. To protect against this downside, there are also some hybrid annuities, such as the Fixed Indexed Annuity.

Fixed Indexed Annuities provide interest annually by a certain index that is tied to market. Interest is invested in one of several indexes, most commonly the S&P 500. This is not a direct investment in the market and remains a great option for those who want to be protected from market downside.

Immediate and Deferred Distributions

The distribution phase relates to when you start receiving your payments. Immediate annuities distribute directly after the deposit of a lump sum into the policy, providing payments — typically a month at a time — for the rest of retirement. If you were to die before the all the money was paid, the rest would go to your beneficiaries.

Deferred annuities are the opposite, where payments do not start until you reach a certain age specified in the annuity contract. At the appointed time, you can choose whether to receive the income stream or the amount to which it has accumulated.

Talk to a Financial Expert Today

If you had not heard of annuities before, or if you had but did not quite understand what they were, you would not be alone. Many of us do not know every financial option available — that is why we need financial advisors to help us put together educated financial plans. If you are looking to provide a steady income stream in retirement, talk to a financial expert about annuity options today.


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