Annuities have emerged in recent years as a favorite financial tool for financial planners when assisting their individual investor clients. However, like all retirement planning vehicles, the more you understand about how an annuity product works, the better choices you will make for your unique financial situation. Below we will discuss the basics of an annuity and how to evaluate specific annuities for your own retirement needs.

At the most basic level, an annuity is an insurance asset protection and income producing a financial product that can deliver a lifetime guaranteed income stream to the owner. As an individual, you purchase an annuity through the issuer using a one-time lump sum payment or, in some cases, via a series of regular standard payments referred to as premiums. If you make a lump sum payment and begin receiving income payments for life (or for a specified period), then you have purchased an  immediate annuity or a deferred annuity with an income rider. On the other hand, a deferred annuity may require that the purchaser fund the annuity for a certain period before receiving any payments. Prior to payout, the initial principal/premium and money added can remain deferred for tax-free growth. The payout can be optional and used only if needed. Hence, the annuity can remain tax-deferred as a safer growth strategy for one’s portfolio.

In addition to the primary distinction between an immediate or deferred annuity, these products can also be differentiated by their payment calculations and the type of assets the annuity holds. For example, a fixed annuity guarantees a fixed minimum interest rate which is established when the annuity is purchased. While good at first glance, some annuities do not increase for inflation. Your $1,000 monthly payment may become considerably less valuable if inflation heats up. By contrast, a fixed annuity that is tied to an inflation index or a fixed increasing income formula may help to hedge against inflation. Fixed index annuities [FIA] can potentially grow initial contributions more rapidly than standard fixed annuities. The result, if the FIA performs well, is that the payout amounts, which are calculated by the growth of index funds and other limiting factors during the accumulation phase, would be far greater than had the same initial monies been used to purchase a fixed annuity. The fixed index annuity combines features of both the immediate, fixed, and a variable annuity’s growth attributes by linking the accumulated funds to a stock market index for a limited upside producing higher interest earnings while guaranteeing a minimum lifetime payout amount, via an income rider or annuitization.

As you develop a better understanding of annuities, you should ask yourself if an annuity is right for you. For all financial products, you will need to have an understanding of your current finances, what you expect to receive from other income sources in retirement, the degree of risk you want to take with your investments, and what your expected living expenses at retirement will be. These along with other individual factors, such as life expectancy, affect the range of financial instruments that can be used to fund your retirement.

Finally, as you research your options, be sure to understand what you are buying. Annuities can be quite simple, and some may be more complex, so, it is to your advantage to thoroughly review the annuity contract’s features, benefits, and limitations. You may also want to know the annuity fees and commissions. Focus on getting the annuity that best fits your own needs, and that comes from a reputable highly rated issuer. Being able to retire in a secure and comfortable manner is worth a great deal. The breadth of annuity products available today may require a financial planner’s help and one that’s experienced with annuities, of course. Do your research and start taking the steps towards your retirement today.