How Does an Annuity Work?


Quick Answer

An annuity is an insurance product that pays the investor according to a specified schedule. Annuities can be purchased in a lump sum or increments. Annuity payouts can be scheduled monthly, quarterly and annually, or paid out in a lump sum. Periodic annuity payments can be for a set period of time or continue for the remainder of the investor's life.

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Full Answer

Annuities are designed as a tool to provide retirement income. The size of annuity payments is determined by several factors, including the amount of money invested in the annuity, the payment period, and the age of the investor. Payment amounts are also determined by the type of annuity. The periodic payments of a fixed annuity are guaranteed. The periodic payments of a variable annuity are determined by the performance of its underlying assets.

Annuities can also be either deferred or immediate. In an immediate annuity, the investor begins receiving periodic payments soon after making his initial investment. In a deferred annuity, the investor generally does not receive periodic payments for many years. His annuity investment builds tax-deferred in the interim. Annuities are sold by insurance salesmen and financial planners. There are often considerable fees involved in setting up an annuity.

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