What Are Annuities?

Annuities are financial products we can buy to create an income stream for our future.

Waiting on the income

Annuities are divided into two main classes: immediate annuities and deferred annuities. Immediate annuities begin to pay you back immediately, but deferred annuities age for a certain duration before they begin to issue your income. During the period of deferment, you may be permitted to make further premium payments into your deferred annuity in order to increase the size of the income payments you receive later.

Your annuity income

Annuities work a bit like loans: we give money to a life insurance company now, and they repay us with interest. We can have them repay us all at once or in a series of payments. With term certain annuities, that stream of payments will last for a certain number of years.

With life annuities, the duration of that stream of payments varies depending on how long the annuitant-the person whose longevity is chosen to be the measure of the income stream-lives. If the annuitant lives but a very short while, you may receive little or no money back from your investment. You can actually choose to balance out the risks in life annuities and term certain annuities by electing to be paid on whichever schedule lasts longer. However, whenever you pass risk back to the insurance company, it's going to cost you more somehow: your income payments will be of a comparatively smaller size in the future.

Calculating returns

How is the size of your repayments (return on your investment) calculated? There are a number of different options available to you. Your annuity contract can uniformly fix the size of your income payments, guaranteeing your income forever after. Otherwise, you can take control by purchasing a variable annuity: variable annuities permit you to choose how your premiums are invested and to reap the benefits or losses of your investment decisions. With indexed annuities, the size of your income payments is tied to a market index (e.g. wheat, oil, or US $ inflation), so as that index rises and falls, so does your income.

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