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What Are Annuities?

Annuities are contracts issued and sold by financial institutions in which funds are invested with the goal of paying a fixed income stream later. They are used primarily for retirement and help people address the risk of depleting their savings. After annuitization, the holding institution will issue a stream of payments at a later time.

Key Points

  • Annuities are financial products that offer a guaranteed income stream and are used primarily by retirees.
  • Annuities begin in an accumulation phase, during which investors fund the product with a lump sum or periodic payments.
  • Once the annuitization phase begins, the product starts paying the annuitant for a fixed period or for the remainder of the annuitant's life.
  • Annuities can be structured as different types of instruments—fixed, variable, immediate, and deferred income—providing investors with flexibility.
  Annuity products are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Agents or brokers selling annuities must have a state-issued life insurance license and, for variable annuities, a securities license as well. These agents or brokers generally earn a commission based on the annuity contract's notional value.  

How Do They Work?

Annuities have two clear stages: the accumulation phase, the period when an annuity is funded before payments begin, and the annuitization phase, when payments start. Defined benefit pensions and Social Security are two examples of guaranteed lifetime annuities that pay retirees a steady cash flow until they die. Annuities are appropriate financial products for people seeking stable, guaranteed retirement income. Annuities generally have a surrender period. During this period, an investor cannot withdraw funds from the annuity without paying a surrender charge or fee. This period may last several years, and withdrawing the invested amount before it ends can incur a significant penalty.  

Annuities may also include an income rider. This ensures that annuity buyers receive fixed income after the annuity begins. At this point, investors should consider when they want to receive income—at what age—because there are almost always fees associated with the income rider, although some organizations offer it free of charge.