How Does an Annuity Work for Retirement

Managing finances can be an unpleasant experience for many people as financial products are extremely abundant, along with their advantages and disadvantages. The same goes with annuities, another option to prepare for retirement fund. To make a good decision whether to go for an annuity, you have to understand how it works.
 

What is an Annuity -- the Definition


In the United States, an annuity is an agreement between an individual and a company. An individual usually pay a lump sum premium to the other party, often an insurance company. Then, immediately upon reaching retirement age, the insurance company will make regular payments to that particular individual, like a pension, as long as the period specified in the contract.
 

2 Different Types of Annuity Agreements

  • Life Annuity


    This is a more common type for retirement savings. An individual is supposed to pay a lump sum of money to a company and it agrees to pay a specific rate of return on that amount every year for the whole life of that individual.

    Certain life annuities even provide tax benefits as an extra feature to the financial product if they are carried out hand-in-hand with charitable and non-profit organizations.
     

  • Annuity with Period Certain


    The period of the agreement is specified in this type of annuity. For instance, if you pay an insurer $1 million for a 20-year annuity that guarantees a 3% growth over the specified period, then you can expect a monthly check of $5,546 from the insurance company as a retirement income until the end of 20 years. 

Are Annuities as an Investment Benefiting You?


Theoretically, annuities (whether fixed or variable annuities) are good for old folks in their golden years. However, you need to address one main drawback it may cause. The organization that you have signed up the annuity with may fail. Therefore, it is important to purchase an annuity only from organizations with strong financial background, especially when it involves a lot of your savings or money.

The other disadvantage that may arise is, you may not get back enough cash in case of early death, not even the initial capital. Basically, your next of kin is not able to inherit any cash from it.
 

Should You Buy an Annuity?


Every investment tool has its pros and cons. Therefore, taking up an annuity should not be your sole retirement strategy to reduce potential risks mentioned above. You should also look for some other options as well, for example bonds.

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