Annuities 101: Everything You Need to Know

Is the mere mention of the word “annuity” enough to make your eyes glaze over?

If so, we get it. These particular financial funds have a reputation for being difficult for the average consumer to understand. But that doesn’t mean you should ignore how annuities work.

Once you start to understand annuities, you may discover that they’re a fit for you and your retirement income strategy. Learning more about what an annuity is and how they work could improve your financial future. 

What Is an Annuity and How Do Annuities Work?

In the simplest sense, an annuity is a financial product you buy from an insurance company. You make deposits into the product over time and earn interest on your money. Then, when you retire (or whenever you’re ready to receive income), you begin getting a regular stream of payments from your account.

If that sounds a lot like an IRA and/or a CD¹, you’re right. There are similarities among all retirement savings vehicles. After all, each is designed to help you work toward the same goal, and annuity funds are no different.

What Are the Pros and Cons of Annuities?

Pros

• Lifetime income. Annuities can offer guaranteed income for life.²
• No limit on deposits. Other retirement income options have limits on how much you can deposit each year. Annuities do not.
• Higher guaranteed rates. Because they’re invested differently, annuities often offer a higher guaranteed rate than other products.
• Tax-deferred interest. You won’t pay taxes on the interest you earn until you’re ready to begin receiving income from your annuity.

Cons

• Potentially higher tax rates. You pay taxes when you receive your annuity income, and no one can predict what the taxable rate will be at the time.
• Complexity. Annuities can be difficult to understand. You’ll want to work with an advisor you trust.
• Fees. When compared to other retirement investment options, annuities can have higher fees. 

How Do Fixed Annuities and Indexed Annuities Differ?

Each type of annuity has its own unique benefits. Figuring out which one is right for you will depend on factors like your age, risk tolerance and how much you have to invest. You’ll want to discuss each option with an agent before deciding.

Fixed Annuity 

A fixed annuity is perhaps the simplest member of the annuity family. You make deposits to your annuity contract and earn a pre-determined annual interest rate from the company you purchased with. In most cases, you’re also given a guaranteed minimum interest rate, which means you know that you’ll never earn less than that amount on your investment each year. There is a low level of risk with this type of product.

Indexed Annuity

One of the most popular annuities today is the indexed annuity. This product is a blend of its fixed and variable relatives, and that makes it a little more complicated. With an indexed annuity, you have the opportunity to earn higher returns than you would with a fixed annuity, and you can protect yourself from the risk of losses that you might incur with a variable annuity.

How Do You Know if an Annuity Is Right for You?

You’ll want to discuss whether an annuity fund is right for you with your financial advisor. Some examples of when an annuity might make sense include:

• If you’re an investor looking for a steady stream of income throughout retirement
• If you’re an investor looking for a relatively safe way to grow retirement funds, but wanting higher returns than the bank offers on a product like a CD
• If you’re an investor ready to put money aside for a number of years (annuities come with early withdrawal penalties)

One thing is for sure, the decision to purchase an annuity is one you should discuss with a professional. Now that you know what an annuity is, get in touch with your local Farm Bureau agent to understand your options and create a retirement strategy that works for you.