With a deferred annuity, your money is invested for a period of time until you are ready to begin taking withdrawals, typically in retirement.
If you opt for an immediate annuity you begin to receive payments soon after you make your initial investment. For example, you might consider purchasing an immediate annuity as you approach retirement age.
The deferred annuity accumulates money while the immediate annuity pays out. Deferred annuities can also be converted into immediate annuities when the owner wants to start collecting payments.
Within these two categories, annuities can also be either fixed or variable depending on whether the payout is a fixed sum, tied to the performance of the overall market or group of investments, or a combination of the two.
The biggest advantages annuities offer is that they allow you to sock away a larger amount of cash and defer paying taxes.
Unlike other tax-deferred retirement accounts such as 401(k)s and IRAs, there is no annual contribution limit for an annuity. That allows you to put away more money for retirement, and is particularly useful for those that are closest to retirement age and need to catch up.
All the money you invest compounds year after year without any tax bill from Uncle Sam. That ability to keep every dollar invested working for you can be a big advantage over taxable investments.
When you cash out, you can choose to take a lump-sum payment from your annuity, but many retirees prefer to set up guaranteed payments for a specific length of time or the rest of your life, providing a steady stream of income.
The annuity serves as a complement to other retirement income sources, such as Social Security and pension plans.
The money that is invested in the annuity is guaranteed to earn a fixed rate of return throughout the accumulation phase of the annuity (when money is being put into it). During the annuitization phase (when money is being paid out), the balance invested, minus payouts, will continue to grow at this fixed rate.
A Fixed Index Annuity is a tax-favored accumulation product issued by an insurance company. It shares features with fixed deferred interest rate annuities; however, with an index annuity, the annual growth is bench-marked to a stock market index (e.g., Nasdaq, NYSE, S&P500) rather than an interest rate.