In its most basic form, an annuity is a contract or policy between an individual and a company. An individual buys an annuity, and the company gives the individual a payout, typically on a monthly basis, and typically for the remainder of the individual’s life.
In general, annuities are attractive for those who are nearing retirement and looking for monthly income. People typically buy annuities to help manage their retirement income, and so annuities are a good choice for many who are looking to no longer be gainfully employed, according to Investor.gov. Some individuals view the concept of an annuity as a sort of do-it-yourself pension.
Annuities were positioned as a product for anyone, and people have invested all their portfolios into annuities, according to a Forbes article. But, when you think about it, investing your whole portfolio into a single investment doesn’t make sense for any financial instrument. “These investors put themselves at considerable risk by placing all of their eggs in a single basket,” the Forbes article states. “Because of this situation, many states now regulate the percentage of annuities you can hold in your portfolio.”
There’s a long list of people for whom annuities are an appropriate investment, according to the Alabama Department of Insurance. Many people purchase annuities because they don’t belong to retirement plans or because they want to supplement their pensions. Others include people who have sold their business, a couple who has sold its home, a widow or divorcee who needs to maximize income but wants the safety of monthly payments or a grandparent who wants to provide for grandchildren.
Annuities offer three major benefits. They provide:
Periodic payments for a particular period of time. The time frame might be for the rest of an individual’s life, or for the remainder of the spouse’s or other specific person’s life.
Death benefits. If an individual dies before he or she begins receiving payments the beneficiary will receive the payments instead.
Tax-deferred growth. Individuals don’t pay taxes on either the income or the investment gains from their annuities until they withdraw the money.
There are more benefits, as well. American Family Administrators, a national estate planning firm based in San Juan Capistrano, Calif., said that while deferral of taxes is a big benefit, “so is the ability to put large sums of money into an annuity—more than is allowed annually in a 401(k) plan or an IRA—all at once or over a period of time.” In addition, annuities can help an estate avoid probate since beneficiaries receive the annuity proceeds with no time delay or probate expenses. And annuities offer flexible payout options that help retirees meet their cash-flow needs.
Unlike other tax-deferred retirement accounts like IRAs and 401(k)s, there’s no contribution limit for an annuity, according to CNN Money’s Ultimate Guide to Retirement. “That allows you to put away more money for retirement, and is particularly useful for those that are closest to retirement age and need to catch up,” it states.