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How Do Annuities Work?

Annuities are often surrounded by misconceptions, despite their popularity. Let's take a quick look at what an annuity is and how it works to reveal how this tested product might help you secure a stable retirement.

An annuity is a long-term contract between you and an insurance company that is designed to help you achieve a variety of financial goals. In some cases, the policy may help you defer taxes on your money, protect your money from market fluctuation, provide guaranteed income for life, or a combination of these features! And there are more options available depending on your needs.

A policy may help you defer taxes, protect principal, and provide lifetime income guarantees.

There are three primary categories of annuities used to help individuals accumulate wealth for retirement: Fixed, fixed indexed, and variable. All three can be purchased with a lump sum as a single premium, or with intermittent flexible premium payments.

  • The Fixed annuity offers a predictable, guaranteed fixed rate. The rate of growth is defined in your policy, usually fixed for a period of 3-5-7 or more years, and is a rate that is determined by the insurance company. This policy type may be right for you if you prefer safety of your money and are uncomfortable with stock market risk.

  • A Fixed Index annuity offers principal protection and instead of a fixed guaranteed rate, allows you the option to participate in market growth potential by tracking an index, such as the S&P 500. This policy also provides tax-deferred growth and predictable future income. Growth inside this policy is earned through the potential interest credits based on the performance of the underlying index. This option might be right for you if you are more interested in market-based growth with loss protection while saving for retirement.

  • The Variable annuity offers an array of investment options to help grow retirement savings and create steady income in retirement. Your account value fluctuates depending on the market performance of your underlying investments. Again, you will have tax-deferral of any growth inside the policy, and you may be able to purchase a rider to provide a guaranteed payout amount when you wan to start taking income. A variable design might be right for you if you want higher growth potential and are willing to accept more risk of principal.

You don't have to evaluate these options on your own, as there are many additional selections available to you. We are experts in this arena and can help you through the maze of features and benefits to uncover the policy design that best suits your needs and risk tolerance.

In our next post, we will consider the myths surrounding annuities and how these products may work well for those preparing for or in retirement.


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