What Is an Annuity (in Simple Terms)?
Annuities can be confusing. Here's a plain-language explanation of what annuities are, how they work, and who they're for.
What Is an Annuity?
An annuity is a contract with an insurance company. You give them a lump sum (or make payments), and in return, they provide you with regular payments—either immediately or in the future.
Think of it as the opposite of life insurance: life insurance protects against dying too soon, while annuities protect against living too long and running out of money.
Two Main Types
Income Annuities
Convert a lump sum into guaranteed monthly payments for life or a set period. Designed to provide predictable retirement income you can't outlive.
Best for: Retirees wanting guaranteed income, people worried about outliving savings, supplementing Social Security.
Accumulation Annuities
Designed to grow your money tax-deferred over time. You contribute funds, they grow, and you can later convert to income payments or take withdrawals.
Best for: People who've maxed out 401(k) and IRA contributions, those wanting tax-deferred growth, protecting savings from market volatility.
How Do Annuities Work?
1. You Pay Premiums
You give the insurance company money—either a lump sum or regular payments.
2. Money Grows (or Pays Out)
For accumulation annuities, your money grows tax-deferred. For income annuities, payments begin immediately or at a future date.
3. You Receive Payments
You get regular payments—either for life (with lifetime options) or for a set period.
Key Benefits
- ✓ Guaranteed income for life (with lifetime options)
- ✓ Protection against outliving your savings
- ✓ Tax-deferred growth (for accumulation annuities)
- ✓ Protection from market volatility
- ✓ Predictable monthly payments
- ✓ No contribution limits (unlike 401(k)s and IRAs)
Important Considerations
- • Once you purchase an income annuity, you typically can't access the lump sum
- • Payments may be fixed and won't increase with inflation (unless you pay extra)
- • Early withdrawals may incur penalties (before age 59½)
- • Surrender charges may apply if you withdraw too early
- • Growth may be limited compared to direct market investments
Who Are Annuities For?
Annuities can be a good fit for:
- • Retirees or near-retirees wanting guaranteed income
- • People worried about outliving their savings
- • Those who want to protect a portion of retirement savings from market volatility
- • People who've maxed out other retirement accounts
- • Those planning for future retirement income
401(k) Rollovers into Annuities
You can roll over funds from a 401(k) into annuities to shield your retirement savings from market volatility while maintaining tax-deferred status. This can be especially valuable if you're concerned about market downturns affecting your retirement savings.
Is an Annuity Right for You?
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