How Do Annuities Work

People invest in annuities to supplement their present income or their retirement income. Annuities involve making a lump some, huge payment to the insurance company at once, and then reaping it's rewards by getting small payments in return over a specified period of time by the insurance company. Let us learn in detail about how do annuities work.

How Do Annuities Work

As mentioned above, the first thing that an investor does is fund the annuity. Annuities are completely opposite to the insurance policies. In insurance policies, the purchaser has to pay a periodic premium to the insurance company, and just in case the purchaser dies, his beneficiaries will get the entire amount of the policy. In annuities, the purchaser pays a bulk amount in the beginning, and gets periodic payments from the insurance company till the time specified in the annuity agreement. If the annuitant dies, these payments by the insurance company stops and the annuity agreement stands terminated thereafter. However, nowadays there are lots of annuity schemes which cover the spouse as well, i.e. the payments continue to be given to the spouse of the purchaser even after he/she has expired. The annuity agreement in such a case terminates after the spouse of the purchaser expires. Here are a few more things that will give you a better idea of how annuities work.

• The annuities can be purchased with one bulk payment or they can be purchased with a series of payments.
• The annuity period can be either the lifetime of the purchaser or the lifetime of his spouse in case the purchaser expires or it can also be for a specific number of years such as twenty five years.
• The periodic payments that the purchaser receives, can both be immediate, i.e. the returns start immediately, or they can be deferred payments, i.e. payments start once the purchaser retires.
• Besides insurance companies, many reputed charities too form annuity agreements with people. If you want to know how do charitable gift annuities work, it's the same way as the normal annuities sold by the insurance company, wherein people pay a specified gift amount to the charity, and get a lifetime income in return.

Types of Annuities

Annuities are basically of three types, namely, fixed annuities, variable annuities and equity-indexed annuities. Let us learn how each of these give returns.

How Do Fixed Annuities Work
If a purchaser has invested in a fixed annuity, the insurance company takes that amount and puts it in a fixed fund, which gives the same returns period after period. So, the changes in the economy does not affect the return amount.

How Do Variable Annuities Work
If a purchaser has invested in a variable annuity, the return amount will change in accordance with the changes in the economy. If the market goes up, the returns will increase, and vice-versa. Sometimes, a minimum amount may be fixed in the annuity agreement which will be paid to the purchaser, just in case the returns are too low.

How Do Equity-Indexed Annuities Work
This is a mix of the fixed and variable annuities. In this, the principal amount remains protected, while the interests may vary according to the changes in the market index.

I hope now you know how do annuities work. The profitability of the annuity agreement depends a great deal on how long the investor or his spouse live. It can be a very good investment as far as post retirement is concerned, as most annuities are tax deferred.