What is an annuity?

Last updated: March 2022

An annuity is one way you may be able to help fund your retirement years. An annuity is a contract between you and your insurer that can be used to provide income during retirement, says the Securities Exchange Commission (SEC).

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Types of Annuities

Before choosing an annuity, it's important to understand the different types and how they might affect your financial picture. The main categories of annuities include:

Fixed annuities:

A fixed annuity offers a specified interest rate during the accumulation phase, or the period during which your value is growing in the annuity. When you are ready for your stream of payments to begin, the value of your funds is turned into a steady stream of payments that provide a specified payment for either a certain period of time — say, 20 years — or for an indefinite period, such as your lifetime or the lifetime of you and your spouse, the SEC says.*

Variable annuities:

In a variable annuity, you direct funds accumulating in your annuity to investments of your choice that are offered by the insurance company — typically mutual funds, according to the SEC. Your income stream in retirement is dependent upon how well your investments performed during the annuity's accumulation phase, the SEC says.

Indexed annuities:

An indexed annuity provides you with a return that is tied to a major stock market index, such as the Standard & Poor's 500 Composite Index, says the SEC. During the accumulation phase, your investment's rate of return reflects the performance of the selected index. However, these annuities typically also offer returns that are no less than a specified minimum, no matter the index's performance.

Advantages of annuities for retirees

Annuities can be an attractive retirement income choice for a number of reasons, including:

  • Tax deferral: You don't pay taxes on the income and investment gains from your annuity until you begin receiving payments, says the Insurance Information Institute (III).*
  • Lifetime income stream: If you choose to receive annuity payments with a lifetime contingency, an annuity can provide an income stream for the duration of your retirement, the III says.**
  • Death benefit: Should you pass away before you begin receiving payments, the person you name as a beneficiary will receive a specified payment, according to Investor.gov.

Depending upon your state of residence, annuities may also offer other benefits, such as protection of your investment from creditors. For these reasons and more, an annuity may provide you and your family with increased financial security during your retirement. Consult with your insurer or investment professional to determine how you might best benefit from an annuity.