In some form or another, you may have heard annuities mentioned on infomercials or by well-known insurance providers…or even as a viable option if someone wins the lottery. But what exactly are annuities, and why are they primarily the favorite child of insurance salesmen (and ladies)? 

Today on GradMoney’s Macro Mondays, we introduce you to the complex, yet rather beneficial world of annuity investing. Always be sure to consult a fiduciary advisor before deciding to invest in annuities. And for more information on annuities, be sure to check out Investopedia.  

What is an ‘Annuity’? 

An annuity is a contractual financial product sold by financial institutions that is designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual at a later point in time. The period of time when an annuity is being funded and before payouts begin is referred to as the accumulation phase. Once payments commence, the contract is in the annuitization phase.

How do annuities work?

Annuities were designed to be a reliable means of securing a steady cash flow for an individual during their retirement years and to alleviate fears of longevity risk, or outliving one’s assets.

Annuities can also be created to turn a substantial lump sum into a steady cash flow, such as for winners of large cash settlements from a lawsuit or from winning the lottery.

Defined benefit pensions and Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass.

What kinds of annuities exist?

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. Annuities can be created so that, upon annuitization, payments will 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. Furthermore, annuities can begin immediately upon deposit of a lump sum, or they can be structured as deferred benefits.