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What Is an Annuity And Why You May Want One 

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Annuities are generally considered to be retirement products, though they can be used to provide someone who received a large settlement predictable income. Annuities can be used alongside retirement accounts like the 401K and IRA when planning for your future. But what is an annuity? And why may you want one? We’ll answer both of these questions in detail. 

 

What Is an Annuity? 

Annuities go back to the Roman era. Someone would enter a contract, giving the other party their money in exchange for an annual payment for the rest of their lives. That’s the source of the name “annuity” even if you’re getting quarterly or monthly payments. Fixed annuities are similar to the classic annuity. You get a set rate of return for the duration of the contract, though the contract may specify “for the rest of your life”. Fixed rate annuities are an insurance product.

Variable rate annuities can yield higher rates of return but come with more risk. In general, they invest part of the money into the market. They pay you higher returns when the market is up, but you get less money when the market is down. Depending on how the annuity contract is structured, you may not get anything if the market is down. You can choose an annuity contract with a minimum payment so that you have financial security. 

 

Why Might You Want to Get an Annuity? 

The biggest reason why people get annuities is for the financial guarantee. You are guaranteed to get X dollars a year from your fixed rate annuity. You can pay for a cost-of-living rider to increase that amount at the rate of inflation. If the stock market crashes or the company stock you put in your 401K is worthless because the company went bankrupt, you have little to nothing in your retirement account. Furthermore, annuities are backed by state guaranty programs like other types of insurance. This means that your annuity will be paid by the state if the annuity company goes bankrupt.

Annuities are often used when the person doesn’t want to manage their money. They may be afraid of investing in the stock market. Or they don’t want the hassle of monitoring investments. Annuities will also provide stable income even as the person’s physical and mental health declines. You can also sign up for a joint annuity that guarantees your spouse income when you pass. That provides peace of mind. 

 

What Factors Determine Annuity Rates

The rate of return on an annuity is based on the risk the insurer will have to make significant payments over time. This is in turn primarily based on your life expectancy. This is why the rate of return on an annuity goes up with age and drops if you add a spouse. You’ll either have to pay more or receive a smaller check if you want the annuity to include inflation protection.

Variable annuities may or may not offer inflation protection. They are tied to the stock market returns, not the official interest rate. You’ll get more money when the market is doing well and less when the market is down. 


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