Annuities Explained: A Secure Way to Convert Savings into Retirement Income
**Annuities** are financial contracts issued by insurance companies designed to accept and grow funds from an individual and then pay out a stream of payments later in life. They are primarily used as a tool to mitigate the risk of outliving your money, offering a form of guaranteed **retirement income**.
The Two Phases of an Annuity
All annuities operate in two distinct stages:
- Accumulation Phase: You pay money into the annuity (either a lump sum or periodic payments). The money grows tax-deferred, meaning you don’t pay taxes on the interest or investment gains until you withdraw the money.
- Payout (Annuitization) Phase: The money is converted into a guaranteed stream of income payments that can last for a set period or for the rest of your life.
Choosing Your Type of Annuity
The growth phase is where the main difference lies:
- Fixed Annuity: Guarantees a minimum interest rate for a period. This is the safest type and offers predictable growth, similar to a bank CD but with tax deferral.
- Variable Annuity: Allows you to invest the money in sub-accounts (similar to mutual funds). The rate of return is tied to the market, meaning higher risk and potential higher reward.
- Indexed Annuity: A hybrid that offers market-linked growth, but with a guaranteed minimum interest rate to protect against market losses.
Key Benefit: Guaranteed Lifetime Income
The primary appeal of an **annuity** is the ability to create a “personal pension.” Once you annuitize, the insurance company contractually guarantees payments for as long as you live, addressing the fear of outliving your savings—a risk that 401(k)s and IRAs alone cannot solve.