Annuities: Understand the Basics

Annuities Explained

This is annuities explained in basic terms. Basically, if you get payments at regular intervals, that’s an annuity. Money is put into an account with an insurance company, and in return the company offers certain benefits. One of those benefits is the possibility of recurring monthly or annual payments. However, annuities work differently than other retirement options. This is because they aren’t investments, per se, but more agreements.

How annuities work for retirees is due in large part to what their contract language is. Some types of annuities, for instance, may provide a fixed interest rate. Others may give owners a potential increase of earnings when the annuity index rises. But in both cases, the annuity protects the money that the owner put into it.

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The Insurance Company’s Role

Market fluctuations don’t drop the principal value of a fixed indexed annuity. It’s a requirement for the insurance company to keep your initial deposit safe. You provide a certain sum of money, and the insurance company agrees to issue you a certain amount. This amount might be in the form of monthly or yearly payments. The insurance company sets aside a reserve amount in order to provide protection for your assets, as required by law. A fixed indexed annuity may be able to offer protection from market crashes or downturns because of this.

Two Main Phases

There are 2 primary phases to an annuity agreement, accumulation and distribution.

During accumulation, you let your money grow. There are different rules as to if/when growth may occur, depending on the type of annuity. Fixed indexed annuities, for instance, usually have some growth potential, but may also have a set interest rate. But the value never drops, even if the market crashes. Then there’s variable indexed annuities. They have more risk, because they link directly to the stock market. In either case, though, the money in the annuity has a period that you have to wait through.

During distribution, you can begin taking money out. How much you can take out, and when it can be taken out, will vary depending on your contract terms. With a fixed indexed annuity, you may be able to take specific annual or monthly payments without penalty. Of course, you must pay applicable taxes. Tax implications will vary from person to person, though, so be sure to consult a tax advisor if you have any tax-specific questions. Regardless, this phase may be able to offer you an income for life in retirement.


So, annuities explained in terms of taxes. During the first stage, the growth in your fixed indexed annuity account doesn’t incur immediate taxes. Unlike a CD, or a traditional savings account, an FIA doesn’t require taxes until the money is taken out. For those looking for alternatives in tax planning, this could be useful information.

There are other possible benefits, too. For instance, if you’re younger than 59 1/2 and get an early retirement package. Let’s say you get a lump sum for the employer’s 401(K) profit-sharing plan, this would usually generate a large tax bill. But if this money could be rolled into an annuity, it might be possible to put off those taxes. You should, of course, always discuss things with a professional before moving forward.

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