An annuity is a contract with an insurance company where you make a payment or series of payments in exchange for regular income payments in the future. Often used for retirement planning, annuities are unique in their ability to provide guaranteed income for life.
While the term ‘annuity’ originates from the Latin word for ‘income,’ it’s important to distinguish it from other financial products. It’s not life insurance, health insurance, a savings account, or a short-term investment. Annuities fall into two primary categories: fixed and variable. A ‘deferred’ annuity provides income later, while an ‘immediate’ annuity starts paying out right away. A ‘fixed’ annuity offers a minimum guaranteed interest rate on your premium.
Fixed deferred annuities have two key interest rate components: a current interest rate and a minimum guaranteed interest rate. The minimum rate, specified in your contract, is the lowest possible return you’ll receive. The current rate is determined by the insurance company’s investment portfolio performance or an external index. You can start receiving income from a fixed deferred annuity relatively quickly, although waiting a year before withdrawing interest can be advantageous.
Fixed annuities can be used within an IRA to provide a guaranteed retirement income stream that lasts a lifetime. Insurance companies are legally obligated to maintain reserves to support these guarantees.