The Ins & Outs of an Annuity

The first question you're likely to ask yourself when entering the annuity universe is how does an annuity work? The answer to how does an annuity work depends on the type of annuity program you select. Deferred annuities provide an accumulation of retirement assets, while deferred annuities are designed to provide a stream of income, typically within a year of the annuity contract's purchase.

Types of Annuities

The simplest type of annuity is called the Single Premium Annuity (SPIA), and it requires you to make a lump sum payment to an insurance firm on the date at which you want payouts to begin. Payments may be maximized for as long as you live, if the SPIA contract specifies these payments. In this case, the payment amount is likely to be greater than returns produced from other kinds of fixed-dollar investments, but your income will not run out during your lifetime. On the other hand, if you die after receiving only a few payments under this contract, you will have put in more money than you ultimately received.

The Single Premium Deferred Annuity (SPDA) allows for deferred payments instead of immediate income. You make the single lump sum payment to the insurer, but payments to you will not begin until the contract's maturity date. On this date, you may take the total value of the contract or receive annuity payments. Some deferred annuity contracts will allow you to make periodic payments instead of the lump sum and build up value over time. As you make each periodic payment, the money in your account increases as a result. When you reach retirement age (or some other date specified in the contract), you will begin to receive annuity payments.

Annuity Options

There are different types of pay-in, withdrawal, and investment options available, depending on the kind of contract you select. With a single premium annuity, you invest a single lump sum amount, while flexible premium annuities let you make a minimal investment, with various payments amounts during the investment period. Fixed annuities generally use more conservative investment vehicles such as bonds, and guarantee your principal investment and minimum earnings interest rate. Variable annuities are usually invested in mutual funds, and the principal is not guaranteed. Also, the earnings on your investment determine your payouts.

Things to Consider

Annuities are not insured by banks, the Federal Deposit Insurance Corporation, or any other federal agency. These accounts are not deposits or obligations of a bank or a bank affiliate. They are not underwritten or guaranteed by any agency. In the case of a deferred annuity, there is an element of investment risk involved, including the loss of your principal.

I write columns on annuity investment. If you're looking for expert annuity advice, read more of my articles at: Annuity Articles Annuity types have you confused? Use Steven's handy annuity investor guide to determine which annuity types is ideal for you: Guide to Annuity Types

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