Explain an Annuity

An annuity is one way to invest savings for retirement.
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During tough economic times, making a decision about where to invest for retirement may be even more difficult than usual. Many people do not want to depend on volatile stocks or low-interest savings accounts to secure future income. An annuity, which is available through life insurance companies, offers a fixed future income based on the sum paid into the account and interest earned on the principal.

The Basics

The owner of an annuity signs a written contract with a life insurance company and pays the premiums, which are calculated based on the benefits to be paid out and the age and life expectancy of the annuitant, who will receive the future annuity payments. The owner and the annuitant are often the same person. The owner may also appoint a beneficiary for the death benefit related to the annuity.


The owner of an annuity may fund the account in one of three ways. An annuity can be funded with a single lump-sum payment. But no additional money may be added to the account. An annuity can also be funded based on a schedule that specifies payment amounts and when they may be deposited. In addition, an annuity can be funded with multiple, flexible payments as long as the monetary and time limits established by the contract are not exceeded.


The money in a fixed annuity earns interest at a rate guaranteed to not be below a minimum specified by the contract. When the annuity starts to provide income payments, the payments are a fixed amount. A special type of fixed annuity that bases returns on a market index such as the Dow Jones Industrial Average is known as an indexed annuity. The indexed annuity has protections in place to prevent losses to the principal amount.

With a variable annuity, the owner decides how the principal will be invested. While the owner may elect to place the money in a fixed account with a guaranteed minimum return, the money can also be invested in stocks, bonds or other funds that have no guarantee. The benefits paid out on a variable annuity may either be fixed or variable, depending on the terms of the contract. Variable annuities are regulated by the U.S. Securities and Exchange Commission, while fixed annuities are not.


An insurance company may charge various fees for managing an annuity, such as percentage-of-premium charges, contract fees and transaction fees. The company may also deduct a percentage from each premium before adding interest earned. In addition, the company may charge a one-time or annual contract fee. A transaction fee can be placed on each transaction conducted, which includes premium payments.

Income Payments

Various income options are available. A "straight life" option pays income only as long as the annuitant lives. A "life with period certain" option provides income for a set number or years. If the annuitant dies before the period ends, his beneficiary receives payments. If the annuitant lives past the period specified, he will continue to receive income until his death. A "joint and survivor" option provides income during the lifetimes of both the annuitant and the beneficiary.

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