An annuity is financial contract in which an investor pays a lump sum of money to an insurance company in return for a series of future payments. These investments also enjoy some tax-deferred benefits.
This is the more traditional type of annuity – the insurance guarantees a specific interest rate that you will earn on the annuity. In this case you will know in advance exactly how much the payments will be. Annuities make payments for life or for a set number of years.
This type of investment is different because the investor has some options as to what type of investments are used to grow the money in the annuity. The payments from variable annuities are dependent on the investment return so you don’t know what the payments will be in advance. Variable annuities tend to have very high fees and should be avoided.
What are they for?
Buying an annuity is like buying an investment product that gives you a guaranteed pension. If a retiree is worried that their investment portfolio is not going to last then purchasing an annuity with some or all of the portfolio might be a way to reduce stress.
One possible strategy for retirees, is to use part of their investment portfolio to buy just enough annuity payments (combined with their Social Security payments) to guarantee a minimum standard of living regardless of how poorly the rest of their portfolio performs.
Annuities are cheaper as you get older (ie the payouts get higher) so they are a better option for older retirees.