What Is an Annuity?

An annuity is a contract issued by a life insurance company.

That is the simplest way to understand it.

You transfer money to an insurance company, and in return the company provides specific contractual guarantees.

Those guarantees can be used for principal protection, lifetime income, legacy planning, or certain long-term care needs.

An annuity is not something you should buy because of hypothetical growth or a sales illustration. The contract itself is what matters.

Key Takeaways

• An annuity is a contract issued by a life insurance company.
• Annuities are generally used for Principal Protection, Income for Life, Legacy, and Long-Term Care.
• Annuities are transfer-of-risk products.
• Lifetime income is one of the primary reasons people use annuities in retirement.
• MYGAs can provide a guaranteed interest rate for a specific period.
• Annuities should be evaluated based on contractual guarantees rather than hypothetical returns.

Annuities Are Contracts

When you purchase an annuity, you receive a policy from the issuing insurance company.

That policy spells out:

• what is guaranteed
• how long the guarantee lasts
• when income can begin
• how withdrawals work
• what beneficiaries may receive
• what restrictions apply

That is why the contract matters more than the sales presentation.

What Do Annuities Solve For?

Annuities generally solve four primary objectives using the PILL framework:

• Principal Protection
• Income for Life
• Legacy
• Long-Term Care

If you do not need to solve for one or more of those objectives, you may not need an annuity.

Annuities Are Transfer-of-Risk Products

An annuity allows you to transfer certain financial risks to a life insurance company.

For example, you may want to transfer the risk of:

• losing principal
• outliving your money
• not having enough guaranteed retirement income
• leaving a financial legacy
• certain long-term care needs

The insurance company accepts that risk according to the terms of the contract.

Annuities and Principal Protection

Principal protection is one of the primary reasons people use fixed annuities.

A Multi-Year Guarantee Annuity, or MYGA, provides a guaranteed interest rate for a specific period.

Terms can vary by carrier and can range from relatively short durations to longer periods.

The important part is that the interest rate is contractually guaranteed for the selected term.

Annuities and Lifetime Income

Lifetime income is another major use for annuities.

An annuity can contractually provide income for as long as you live.

If structured jointly, the income can continue for as long as either covered person is alive.

That makes annuities useful for retirees who want to build an income floor alongside Social Security or a pension.

Social Security Is Already Lifetime Income

For many retirees, Social Security is the foundation of their income floor.

It pays for as long as you live.

If you also have a pension, that adds another lifetime income stream.

An annuity can potentially fill the remaining gap between those dependable income sources and the amount you need every month.

What Is an Income Floor?

Your income floor is the dependable money that regularly reaches your bank account.

It may include:

• Social Security
• pension income
• annuity income
• other dependable cash flow

The goal is to determine whether those sources cover the amount you need to live comfortably.

If there is a gap, an annuity may be one way to contractually fill it.

Annuities Are Not Market Investments

An annuity should not be confused with a stock, mutual fund, or other market-based investment.

If your goal is market growth, use products designed for market growth.

Annuities are designed around contractual guarantees.

They are a non-correlated part of a financial plan because their contractual guarantees are not dependent on daily stock market performance.

Do Not Buy an Annuity for Hypothetical Growth

Sales presentations may show:

• hypothetical returns
• back-tested numbers
• projected indexed performance
• large bonuses
• potential future values

Those numbers are not the same as contractual guarantees.

The policy is what you own.

Annuities Can Also Be Used for Legacy

Annuities can also play a role in legacy planning.

For example, MYGAs can grow and compound tax-deferred, allowing assets to accumulate for future beneficiaries.

Other annuity structures can provide beneficiary protections or lifetime income for family members.

The correct structure depends on the goal.

How Do You Know If You Need an Annuity?

Start with two questions:

What do you want the money to contractually do?

When do you want those contractual guarantees to start?

Those answers help determine whether an annuity is appropriate and, if so, which annuity type should be compared.

Compare Carriers for the Guarantee You Need

Annuities are commodity products.

For lifetime income, compare highly rated carriers and the contractual income each one offers.

For guaranteed accumulation, compare MYGA rates and terms.

The product name and company logo should not be more important than the actual guarantee.

Where to Compare Annuities

Use our annuity calculators to compare current contractual guarantees from multiple insurance companies.

You can evaluate lifetime income, MYGA rates, and other annuity solutions based on the specific financial objective you are trying to solve.

The Bottom Line

An annuity is a contract issued by a life insurance company.

Its purpose is to transfer risk and provide specific guarantees.

Those guarantees can include principal protection, lifetime income, legacy benefits, or certain long-term care solutions.

The key is to understand what you want the money to accomplish and choose the annuity based on the contractual guarantee that solves that need.

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