The Basics of Annuity Contracts


When it comes to retirement planning and accumulating savings that will last a lifetime, the question is: To save or not to save?

Most investors would address this financial concern by investing in savings accounts and certificates of deposit (CDs). This was before. But nowadays, many banks in America are offering less than 1% on their savings programs, which means 1000 dollars saved at these institutions will only net $10 in return over time, without inflation.

In addition, most financial world experts agree that 4-6% returns are needed to maintain your value against inflation. However, one may ask how one can achieve this when most institutions provide meager amounts of interest.

So the question is, what would be an excellent financial instrument where you put your hard-earned money? 

Well, anyone concerned about retirement income may be looking at annuities, and rightly so.

They are becoming increasingly popular with an aging population because they can provide several types of benefits that can help improve your future retirement.

But if you are considering an annuity, there’s a lot to know before you buy one, especially If you’re unsure whether an annuity can work for you. Thus it is essential to learn the basics and weigh all the pros and cons.

This article will help you to identify if an annuity can benefit one’s retirement so that one can make an informed decision.

What Is An Annuity?

It is a financial instrument where you can deposit your funds for a specific fixed amount of time and get back the amount you invested and interest on it.

Annuities can be a good investment choice for people who need the income and security of a guaranteed stream of money but don’t want to put all their eggs in one basket.

They’re also helpful for people who want to reduce the risk associated with investing in stocks and bonds.

Annuities nowadays have a lot of similarities with life insurance policies, but they do not guarantee any returns in case of death.

The critical difference between an annuity and other contracts is that the person making payments gets back more than they paid.

For example, if you buy a car for $20,000 and sell it for $22,000 five years later, you’ll have made $2,000.

But if you invest $20,000 in an annuity that pays 2% interest per year for five years (for total interest payments of $400), then sell it back to the company at maturity, you’ll get back more than what you paid — namely $23,040 ($20,000 plus $3,040).

How Is It Structured?

One of the most important things to know about an annuity is that there are three parts to a contract: the contract owner, annuitant, and beneficiary.

Contract Owner

The owner is the person who owns the annuity. They can purchase and fund annuities, change beneficiaries, withdraw money from their contracts, pay premiums, surrender their contracts or make changes before you annuitize them. 

The owner can be a person or an entity, such as a trust or charity.


An annuitant is someone who has purchased an insurance contract and will receive payments for life or for a limited time. 

An annuitant must be a person—not an entity—and their life expectancy determines their payments.


A beneficiary is the designated recipient of an annuity’s proceeds in case something happens to the original buyer/owner or if they want to change their beneficiary at some point during their lifetime.

Types Of Annuity Contracts

There are many types, including fixed, variable, and indexed. But there are three basic contracts: immediate, deferred, and flexible premium. Let’s discuss each one below.

Immediate Annuity

An immediate annuity is an account that pays out a fixed amount each month for the duration of a person’s life.

Some offer a lifetime payout, which means the payments need to continue even if the owner dies before the end of the contract period.

Other types only pay out to age 85 or 90 or until death occurs within a specific time frame after purchase.

Deferred Annuity

A deferred annuity is an investment account that provides periodic payments based on how long you’ve had it open and how much money you invested initially.

You can choose when to start receiving payments and how much money to withdraw each month or year.

Some allow withdrawals before any accumulated earnings are paid out. Others don’t.

Single-Premium Deferred Annuities

A single-premium deferred annuity is a type of annuity that allows you to put money away for retirement while also providing you with income.

It is a savings account, but with a twist: You can earn interest on your money and leave it there for years or decades or withdraw it at any time.

This is different from others, which require you to purchase them with an initial payment (the “premium”) and then make additional premium payments until the contract expires.

The main benefit is flexibility.

You have complete control over your money and can access it whenever you need it. However, some drawbacks are also associated with this type of investment product.

Flexible-Premium Deferred Annuities

A flexible-premium deferred annuity is a type of annuity that allows you to make contributions at any time rather than at the beginning of the contract. 

The amount of your contribution determines the annual payment you will receive.

You can also withdraw any amount from your account without incurring any taxes or penalties, as long as you repay it within five years.

The maximum withdrawal allowed is generally 10% of your total contract value each year for the first five years after opening your account.

After that period, you can withdraw up to 20% per year without penalty.

A deferred annuity guarantees that your payments will be available for future use and does not require an initial investment (although there may be fees

How To Make An Annuity Work For You

The following steps will help you determine if an annuity is right for you:

Understand what an annuity is.

An insurance company sells this type of contract to provide a stream of income payments over time. Annuities can be fixed or variable and come with several different payout options.

Look at different types of annuities.

Many types of annuities vary by investment risk and payout options.

For example, variable annuities allow you to choose from several sub-accounts, including stock, bond, and money market funds. 

In contrast, fixed and indexed annuities have set interest rates or indexes that determine their payouts.

Compare fees and commissions.

Because many different types of annuities are available on the market today, it’s important to compare fees and commissions when selecting the one that best meets your needs.

You may want to consider determining how much commission an agent will receive if they sell you a particular type of annuity product before deciding whether or not to work with them further on your purchase decision.

Ensure you understand the fees associated with each type of annuity, including surrender, mortality, and expense charges.

You should also compare the annual operating expenses of each product as well as any additional fees or commissions that the insurance company may charge if your contract is sold.

Final Thoughts

there’s no such thing as a one-size-fits-all investment. Annuities are a helpful type of savings for many people. You can use them for many purposes, including retirement savings, estate planning, and funding education expenses.

They’re also a form of insurance.

If you pass away before the end of the contract term, any funds you withdrew before death will be paid back into your original account balance (minus fees).

On the other hand, the insurance company will give any funds remaining in the account at death according to the terms of your contract — typically over ten years or less.

But they’re not suitable for everyone. Therefore, you need to consider your situation before deciding whether an annuity is right for you.