How does an annuity work?

An annuity works by providing a stream of regular payments to an individual in exchange for an initial payment or a series of payments. This initial payment is called the “premium,” and the regular payments are called “annuity payments.”

There are different types of annuities, but most work on a similar principle. For example, let’s consider a fixed annuity. Suppose you purchase a fixed annuity with an initial payment of $100,000. The insurance company guarantees to pay you a fixed interest rate, say 4%, for a specified period of time, say 10 years. During this period, the insurance company invests your premium in safe investments like bonds or CDs and pays you a fixed amount each year, based on the interest earned and the duration of the annuity.

In this case, you would receive $4,000 per year for 10 years, for a total of $40,000. After the annuity period is over, you can choose to receive the remaining funds as a lump sum or as a series of payments.

Alternatively, you could purchase a variable annuity, which allows you to choose from a range of investment options, such as mutual funds or stocks. The value of the annuity payments would depend on the performance of the investments you choose.

Immediate annuities begin payments immediately after the initial payment, while deferred annuities start payments at a later date. Single-life annuities offer payments for the lifetime of the individual, while joint-life annuities offer payments for the lifetime of both the individual and their spouse.

It is important to note that annuities can have fees and surrender charges, which can impact the overall return on investment. Therefore, it is essential to understand the terms and fees of an annuity before purchasing one.