What is an annuity?
In the simplest of terms: you make a payment in the present, and the seller pays you back even more in the future. Essentially, it works like a loan. This fundamental simplicity brings annuities into the reach of even customers without investment experience or know-how.
Life insurance companies sell annuities; however, the motivation to buy an annuity is quite the opposite of the call for life insurance: an annuity is useful in case you don’t die prematurely. Annuities are used to turn present income into future income, a popular means of providing for retirement.
When will the income start? (immediate, deferred)
The principal division among types of annuity is between immediate and deferred annuities. With immediate annuities, your income starts right away. With deferred annuities, your income begins some time in the future, as specified in your contract. The deferment period is often in the neighborhood of 20 years.
How long will the income last? (life, term certain, lump sum)
Your income stream can last for the remainder of the annuitant’s life (life annuities), for a fixed number of years (term certain), or it may not be an income stream at all but a single payment (lump sum).
How large will the income payments be? (fixed, indexed, variable)
With fixed annuities, your income payments will all be of a fixed amount, determined at the time your contract is created. With indexed annuities, the size of your income correlates with a particular market index. With variable annuities, you choose where your principal is invested, and your income depends on the growth and decline of those investments.