How do annuity payments work

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The term annuity refers to an insurance contract issued and distributed by financial institutions with the intention of paying out invested funds in a fixed income stream in the future. Investors invest in or purchase annuities with monthly premiums or lump-sum payments. The holding institution issues a stream of payments in the future for a specified period of time or for the remainder of the annuitant's life.

Annuities are mainly used for retirement purposes and help individuals address the risk of outliving their savings. Annuities are designed to provide a steady cash flow for people during their retirement years and to alleviate the fears of outliving their assets.

Since these assets may not be enough to sustain their standard of living , some investors may turn to an insurance company or other financial institution to purchase an annuity contract. As such, these financial products are appropriate for investors, who are referred to as annuitants, who want stable, guaranteed retirement income.

Because invested cash is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs to use this financial product.

An annuity goes through several different phases and periods. These are called:. These financial products can be immediate or deferred. Immediate annuities are often purchased by people of any age who have received a large lump sum of money, such as a settlement or lottery win, and who prefer to exchange it for cash flows into the future.

Deferred annuities are structured to grow on a tax-deferred basis and provide annuitants with guaranteed income that begins on a date they specify. Agents or brokers selling annuities need to hold a state-issued life insurance license, and also a securities license in the case of variable annuities.

These agents or brokers typically earn a commission based on the notional value of the annuity contract. Annuities often come with complicated tax considerations, so it's important to understand how they work. As with any other financial product, be sure to consult with a professional before you purchase an annuity contract.

Annuities usually have a surrender period. Annuitants cannot make withdrawals during this time, which may span several years, without paying a surrender charge or fee. Investors must consider their financial requirements during this time period. For example, if a major event requires significant amounts of cash, such as a wedding, then it might be a good idea to evaluate whether the investor can afford to make requisite annuity payments.

Contracts also have an income rider that ensures a fixed income after the annuity kicks in. There are two questions that investors should ask when they consider income riders:.

Individuals who invest in annuities cannot outlive their income stream, which hedges longevity risk. So long as the purchaser understands that they are trading a liquid lump sum for a guaranteed series of cash flows , the product is appropriate.

Some purchasers hope to cash out an annuity in the future at a profit, however, this is not the intended use of the product. Defined benefit pensions and Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass. Annuities can be structured according to a wide array of details and factors, such as the duration of time that payments from the annuity can be guaranteed to continue. As mentioned above, annuities can be created so that payments continue so long as either the annuitant or their spouse if survivorship benefit is elected is alive.

Alternatively, annuities can be structured to pay out funds for a fixed amount of time, such as 20 years, regardless of how long the annuitant lives. Annuities can begin immediately upon deposit of a lump sum, or they can be structured as deferred benefits. The immediate payment annuity begins paying immediately after the annuitant deposits a lump sum. Deferred income annuities, on the other hand, don't begin paying out after the initial investment. Instead, the client specifies an age at which they would like to begin receiving payments from the insurance company.

Annuities can be structured generally as either fixed or variable:. While variable annuities carry some market risk and the potential to lose principal, riders and features can be added to annuity contracts—usually for an extra cost. This allows them to function as hybrid fixed-variable annuities.

Contract owners can benefit from upside portfolio potential while enjoying the protection of a guaranteed lifetime minimum withdrawal benefit if the portfolio drops in value. You also may need access to your savings to pay medical bills. The good thing about considering annuities is that many of them offer a free look period that gives you time to consider the contract and make sure it is the right choice for your life. By and large, annuities are a safe investment. The amount of protection varies from state to state.

States also regulate insurance companies, requiring them to meet financial standards intended to keep them solvent. All insurers that sell annuities must belong to the guaranty associations in the states where they operate. In two states — Florida and Texas — your money in an annuity is protected from creditors and frivolous lawsuits. Most other states provide limited protections. And likewise, in federal bankruptcy cases, the law provides a small amount of protection of annuity assets from creditors.

This is especially important for older people depending on their savings who cannot afford to ride out a down market.

Some people chose to roll all or part of their k savings into annuities as a means of providing a stream of income to fund retirement. Each annuity has different fees and restrictions. Different companies set different investing requirements. But in deciding whether you have enough money to invest in an annuity, it may be best to consider what kind of return your annuity purchase might bring.

That means, each year, you will receive payments totaling an amount equivalent to 5 percent of your investment. You should decide if the money you can spend on an annuity will bring you enough income to make having the annuity worthwhile. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines. Click here to sign up for our newsletter to learn more about financial literacy, investing and important consumer financial news. If you're interested in buying an annuity, a representative will provide you with a free, no-obligation quote.

SMS is committed to excellent customer service. The company can help you find the right insurance agent for your unique financial objectives.

Your web browser is no longer supported by Microsoft. Update your browser for more security, speed and compatibility. If you are interested in learning more about buying or selling annuities, call us at Annuities View Subpages. What Is an Annuity? Annuities Explained. Indexed Annuity. Buying an Annuity. Reasons to Buy an Annuity.

Current Rates. Immediate Annuity Calculator. Structured Settlements View Subpages. What Is a Structured Settlement? How They Work? Payout Options. Pre-Settlement Funding.

Settlements for Minors. Sell My Structured Settlements. Indexed annuity contracts also offer a specified minimum that the contract value will not fall below, regardless of index performance. After a period of time, the insurance company will make payments to you under the terms of your contract.

A fixed indexed annuity is not a stock market investment and does not directly participate in any stock or equity investment. Before deciding on an annuity, you should consider your income needs, risk tolerance and investment objectives. Guarantees are subject to the claims-paying ability of Nationwide Life Insurance Company.

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