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Annuities are often misunderstood by investors due in large part to the complex nature of this financial product. 

Conceptually, an annuity is a contract, typically between an individual and a financial institution.  Generally, the individual will make a single payment or a series of payments into the contract.  At some point in time, the financial institution will begin to pay the individual, based on the contract.

In reality, annuities are a complicated financial product; with many aspects to evaluate. Payout options, features and associated costs, riders, investment choices, and company financial strength are some of the items to be considered.

In more detail, annuities can be “deferred” or “immediate”.  This classification indicates when the company will start making payments to the annuitant; the individual investing in the contract. 

  • For example, an investor, might, at the time of retirement take a portion of their employer retirement plan (401(k), 403(b) or 457 plan) and roll it into an immediate annuity.   This person will begin to receive payments immediately from the financial institution.  In a way, this person has created their own private pension. 
  • As another example, a person in the middle of their career may make either a single investment or a series of investments into an annuity.  This person does not want current income, desires to see income in the future and is funding a deferred annuity. Deferred annuities also defer the taxes on the growth of the investments within the contract until distribution.

Additionally, annuities are also classified as “fixed” or “variable”.  This indicates if the payment received by the individual is locked in and fixed, or if the payment may change and is therefore variable.  

  • In a fixed annuity, the payments received by the individual are fixed, and do not change.  The financial company takes on the investment risk.  In order to limit the company’s risk in a fixed annuity contract, the company will provide lower returns using lower risk investments. One risk associated with fixed annuities is inflation: the $10K annual payment may seem wonderful at the start, but in 20 years inflation will have eroded the purchasing power of the $10K annual payment still being received. 
  • With a variable annuity the amounts paid into the contract and the payments received from the contract are changeable.  The investor takes on the investment risk, not the financial company.  The investor is responsible for selecting “sub accounts” for investments and therefore assumes investment risk.  One risk associated with variable annuities is the investment risk borne by the investor. Depending on how these sub accounts perform, the investor’s future benefits will also vary.  A sub account is like a mutual fund.  Some companies selling annuities refer to sub accounts as separate accounts.

Payment options are varied:

  • Life income, also referred to as a sole – payments are made until the death of the annuitant
  • Income for life with a guaranteed period – payments are made for a defined period of time, even if the annuitant passes on before the stated time period.
  • Term Annuity Certain – fixed dollar amount payment or fixed period payment regardless of the death of the annuitant
  • Life Income with refund – payments are made until the death of the annuitant. If the annuitant dies before receiving the amount invested in the contract, beneficiaries receive a refund of the difference between the amount invested and the actual payments received.
  • Life Income Joint and Survivor – payments are made over the lifetimes of the annuitant and a survivor.
  • Joint Life – payments are made until one of the annuitants passes on, then payments cease.  This payment is typically greater than the payment received in the Life Income Joint and Survivor option.

Generally, payments are higher in a sole payment option.

Costs vary with annuities based on the features chosen by the investor.  Many annuities provide guarantees about returns, protecting principal, minimum withdrawal amounts and many other features.  All of these features carry a cost.  In variable annuities, there are also investment costs associated with the sub accounts.  Additionally, many annuities carry surrender charges.  Surrender charges are imposed by the financial company when an investor cancels the contract.  Surrender charges can be very heavy and may range from 1% to 15% of the value of the surrendered contract.      

Carefully evaluate the financial strength of the Company offering the annuity product.  Company financial strength can be reviewed at a variety of websites.  Visit,

Annuities are a wonderful product for many people. For other people, these products are over-hyped and sold in situations that do not call for an annuity solution. Do your homework, understand the financial products you purchase.