How Does an Annuity Work?
When you buy an annuity, you contribute money either in a lump-sum payment or through contributions over time. The money you contribute grows tax-deferred, meaning you don’t pay taxes on the earnings until you withdraw them.
Once you retire or choose to start receiving income from your annuity, you can annuitize your policy. This means you convert the accumulated value of the annuity into a guaranteed stream of payments. You can choose if you want the payments to last for a specific period or for the rest of your life.
The value of an annuity
If you’re already contributing the maximum amount to other retirement plans, like an IRA or 401(k), an annuity is another way to grow money tax deferred, meaning you don’t pay taxes on the earnings until you withdraw them.
Annuities can be a source of income before or during retirement to help meet:
Extra income needs
Fill the gap between early retirement and the beginning of Social Security benefits or provide more money during the early, more active years of retirement.
Retirement needs
Help cover essential expenses in retirement not covered by Social Security, pension plans or personal savings.
Non-retirement needs
Provide reliable, regular income for things like payments for children’s college expenses.
Create retirement income
Annuities are one way to set yourself up for retirement. They offer guaranteed* death benefits and different payment options. Annuities are also tax-deferred. Tax-deferred means you don’t pay taxes on earnings that accumulate in your policy until you withdraw them. The money you would have paid in taxes each year continues to grow for you. It’s only when you withdraw policy earnings that they’re taxable. If taken before age 59½, a 10% penalty may also apply.
When you invest in an annuity, it makes payments to you on a future date or series of dates. After that, the income you receive from the annuity can be paid monthly, quarterly, annually or even in a lump sum payment. When you own an annuity, you’ll receive regular payments during retirement that you can’t outlive.
When thinking about “what is an annuity?” remember that it’s never too early to start saving for retirement. An annuity can help you reach your retirement goals.
When does an annuity make sense?
Annuities can be a crucial part of your overall financial strategy and retirement planning.
When you’re worried about life’s what-ifs
When you own an annuity, there are a few ways to access your money. For example, you can withdraw a certain amount each year without a surrender charge. You may also be able to withdraw your money without a surrender charge if you’re experiencing declining health (not available in all states).
When you want to leave something to loved ones
Most annuities offer a guaranteed* death benefit that will be paid to your loved ones with no additional cost. Some even offer enhanced death benefit payments for an additional charge.
When you haven’t saved enough for retirement and need to catch up
The sooner you start saving for retirement, the better. Even if you save for retirement through your employer, chances are you will still need to save for retirement in other ways as well.
Annuities can help provide a source of income before or during retirement.
- Extra income needs. Annuities can fill in the time between early retirement and the beginning of Social Security benefits or provide extra income during your more active years of retirement.
- Retirement needs. Cover expenses in retirement that are not covered by Social Security, pension plans or personal savings.
- Non-retirement needs. Provide reliable, regular income, such as payments to college students to cover living expenses.
Learn more about the different types of annuities and how they fit in with your financial strategy.