Annuities are an interesting investment option, especially in these times of economic turmoil. You may have heard about annuities on TV or maybe your financial planner may have mentioned them at one of your meetings, the problem is most of us don’t know what annuities are or how they work. If this sounds like you, let’s walk through some of the basics of annuities and hopefully help you decide whether or not they are right for you and your portfolio.
Annuities are an investment agreement between you (the investor) and an insurance company. Simply put, you give the insurance company a large sum of money, and they pay you back regularly over time the amount you invested plus additional interest for your investment. The amount of interest will depend on whether you choose a fixed annuity or a variable annuity.
Fixed annuities are the simpler of the two main types because the amount of interest is fixed and usually guaranteed for a certain period of time. The amount isn’t enough to make you rich, but it also isn’t bad for an investment vehicle that has very low risk. If you are more interested in a higher return and are willing to take on some risk then variable annuities may be the answer. Variable annuities tie your investment to a variety of other investment vehicles like stocks, bonds, mutual funds or money market accounts, and they allow you to mix and match according to your investment needs. Your payments will then be based on how well your investment choices perform over time.
No matter what type of annuity you choose, the process works in two parts, the pay-in phase and the pay-out phase. During the pay-in phase you make regular payments to the insurance company until you reach the full investment amount agreed upon. You can make these payments either all at once (which is common in the case of structured settlements) or over a period of months or years. Once you have reached the agreed upon annuity value, the pay-out phase will begin.
During the payout phase, the annuity provider makes payments to you periodically. The payments consist of your initial investment plus interest for your investment. The amount of your payment will be based on a combination of the amount you invested initially, divided by your life expectancy and you will receive this amount until you eventually pass away and even if you outlive your initial investment the insurance company is obligated to continue making payments.
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