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Annuities can be a good option for investors seeking steady income during retirement. To get started, it’s important to learn some basic annuity terms. These 12 key terms will help you understand how annuities work and whether they fit your retirement plan. A financial advisor can also help you evaluate an annuity contract for your retirement plan needs.
An annuity is a financial product that provides a steady income stream, often used for retirement planning.
When you buy an annuity, you contribute funds to an insurance company, which agrees to make periodic payments in the future. These payments can be customized to suit your needs, making annuities a dependable way to secure income and stretch your retirement savings.
There are three main types of annuities:
Fixed annuities provide guaranteed payouts for predictable income.
Variable annuities let you invest in funds, with payouts depending on investment performance.
Indexed annuities link returns to a stock market index and offer some protection against market losses.
Annuities come with benefits like guaranteed income and potential tax advantages but also have drawbacks. Most notably, fees can vary widely and affect your returns, and contracts can offer limited liquidity.
A woman comparing different annuity contracts.
If you are considering an annuity as part of your retirement plan, these 12 common terms can help you understand how annuity contracts work:
Annuitant: The annuitant is the person whose life expectancy determines the annuity payments. Their age and life expectancy are used to calculate the payment amounts and they usually receive the income from the annuity.
Beneficiary: A beneficiary is the person or entity chosen to receive any remaining annuity benefits after the annuitant’s death. Naming a beneficiary allows the annuity’s value to be distributed according to your plans.
Accumulation phase: This is the period when you contribute to the annuity. During this time, your contributions grow tax-deferred, allowing the investment to increase in value before payouts begin.
Distribution phase: The distribution phase, also called the payout phase, is when the annuity starts providing income to the annuitant. Payments can be structured as a lump sum or regular installments over a set period.
Surrender charge: A surrender charge is a fee for withdrawing funds from an annuity before a set time. Knowing these charges can help you avoid unexpected costs if you access your money early.
Rider: Riders are optional additions to an annuity contract that customize it to your needs. Common examples include guaranteed lifetime withdrawal benefits and long-term care coverage.
Fixed vs. variable annuities: Fixed annuities provide guaranteed payments, while variable annuities have payments that change based on investment performance. Your choice depends on your risk tolerance and financial goals.
Tax-deferred growth: Annuities grow tax-deferred until you make withdrawals, allowing your investment to potentially grow more over time.
Mortality and expense risk charge: This fee covers the insurance company’s risk of guaranteeing lifetime income and is usually part of variable annuities.
Guaranteed minimum withdrawal benefit (GMWB): Guarantees a minimum withdrawal amount regardless of market performance. This feature provides a safety net for annuitants.
Immediate annuity: Begins payments shortly after a lump sum is paid to the insurer. Immediate annuities are suitable for individuals who need income right away.
Life annuity: Provides payments for the annuitant’s lifetime, offering income that lasts as long as they live. This type of contract can help address concerns about outliving financial resources.
A woman thinking about her retirement plan.
Annuities provide a steady income stream, but understanding the terms can be challenging. Key terms like “deferred annuity” and “immediate annuity” determine when payments begin. “Deferred annuities” let your investment grow tax-deferred until you withdraw, while “immediate annuities” start payouts soon after a lump sum is invested. For more clarity, consider speaking with a certified retirement financial advisor (CRFA).
A financial advisor can help you manage your nest egg to lower retirement taxes and maximize income. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Mandatory distributions from tax-deferred retirement accounts can complicate your post-retirement tax planning. SmartAsset’s RMD calculator can help estimate your required minimum distributions.
Dena Holloway is a writer, editor, and content creator based in the United States. She has written for a variety of publications, including Men With Wings Press, where she covers arts, automotive, travel, and fashion. She's also a certified yoga instructor and works as a freelance copywriter.
