Annuity
An annuity is a contract between a consumer and a life insurance carrier in which the consumer pays one or more premiums and the carrier promises to make periodic payments back to the consumer under specified conditions. The contract is governed by state insurance law, not federal securities law (with the exception of variable annuities, which are dual-regulated). Annuities are designed to address one of two problems: accumulating retirement savings on a tax-deferred basis, or converting a lump sum into guaranteed income that lasts for a specified period or for life.
A 65-year-old retiree wants to convert $200,000 of her IRA into guaranteed monthly income. She purchases a single premium immediate annuity (SPIA) from an A+ rated carrier. The carrier issues a contract paying $1,200 per month for the remainder of her life. If she lives 25 years, she will receive $360,000 in total payments. If she dies in year 8, she will have received $115,200 and the payments stop (under a life-only payout). The carrier prices the contract using the consumer's age, current bond yields, the chosen payout type, and the carrier's mortality assumptions.
Why it matters
Annuities are one of the few financial products that can guarantee income for life. No mutual fund, ETF, or brokerage account can make that promise — they can only project it under assumptions. For retirees concerned about outliving their savings, the annuity contract transfers longevity risk to the carrier in exchange for giving up access to the principal. Whether that tradeoff makes sense depends on the household's other income, life expectancy, and risk tolerance.
How to evaluate
Always identify the contract type (fixed, indexed, variable, immediate, deferred), the issuing carrier, the carrier's financial strength ratings, the surrender schedule, and the tax treatment (qualified or non-qualified). The carrier's rating matters because the consumer is exposed to issuer credit risk for the duration of the contract.
In the contract
The contract document is called the "annuity contract" or "policy." Key sections to review: declarations page (premium, owner, annuitant, beneficiary), schedule of charges, surrender schedule, free withdrawal provision, death benefit, and any riders.
Related terms
Related pages
Researching an annuity? A licensed specialist who has already screened the carriers and contracts can walk you through the trade-offs in plain English.
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