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See Which Annuity Is Right for Me? Annuity Definition: a contract between an individual and an insurance company promising lifelong income in exchange for an upfront payment. Annuities, at their core, are simple financial instruments: you give me a chunk of your savings and I send you a monthly payment for the rest of your life, no matter how long you live. In practice, this arrangement gets fleshed out in various ways. The most common scenario is when retirees see that their savings aren’t sufficient to last through all of retirement, and make an upfront payment to a life insurance company in exchange for a promise of life-long monthly income. Annuities Explained by Type As always, the devil is in the details.

What type of annuities exist and how do they actually work? There a several fundamental types of annuities geared to different retirement planning stages. Deferred annuities are used to generate savings. Immediate annuities are used to extend the purchasing power of an existing nestegg. Immediate annuities work like CDs, where a large chunk of one’s retirement savings is given to a life insurance company in exchange for a life-long stream of monthly payments. The key difference between CDs and immediate annuities, is that the annuity pays a higher interest rate and guarantees a stream of income that cannot be outlived, which is ideal for retirees. Three Other Types of Annuities Beyond the funding distinction that separates deferred from immediate annuities, there is also the different ways annuities generate income.

Fixed Annuities: interest earned from debt instruments like CDs, bonds, and mortgages. Variable Annuities: interest earned from equity instruments like stocks and commodities. Fixed Annuities An investment in fixed-interest instruments like CDs, bonds, mortgages, and various others debt-investments gives rise to the fixed annuity. A fixed annuity most-resembles a CD in that it guarantees a fixed-interest rate up front. The fixed annuity contract specifies an interest rate that funds will earn for every year they’re held by the insurance company.

Variable Annuities Alternatively, an investment can be made in equities-based instruments and commodities, which gives rise to the variable annuity. A variable annuity most-resembles a 401k in that the account balance fluctuates with the ebb and flow of the markets. Indexed Annuities The final alternative to how annuity income gets generated is called the indexed annuity. P 500, but with protection against capital loss. Essentially, the insurance company caps earnings during high-growth up markets in exchange for covering investors against any losses during down markets.