An annuity is a sum of money that a financial company agrees to provide you in payments over time. This is usually done in return for your agreement to provide the company with a large amount of money or other assets, called the principal on the annuity. Many annuities are structured as insurance policies, providing compensation for later years in life. The amount you pay out will depend on a number of variables.
You can take out two types of annuities -- fixed and variable. Under a fixed annuity, you know exactly how much money you will receive each year the plan pays. This is because the amount of money is fixed ahead of time. The exact amount will depend on the value of the principal, but the issuing company will provide a full account ahead of time.
Variable annuities fluctuate in value. The exact amount that you receive each payment period will depend on a number of factors, including the value of your assets and the prevailing interest rates, depending on the way in which the annuity is structured. Although variable annuities are riskier than fixed annuities, they have the potential for a higher rate of return on your investment.
Value of Assets
The payments from your variable annuity will change in value depending on changes in the value of the investment that underlie the annuity. As these assets become more valuable, you receive more money. In addition, many variable annuities are pegged to prevailing rates of interest. As the interest rate goes up, so does the size of the payment you receive. As they drop, so does the payment.
Some indexes are also pegged to changes in inflation. Some people on fixed annuities receive slightly different amounts of money each pay period depending on changes in inflation. This allows you to still receive enough money to on, even if inflation rises dramatically. However, many annuities are not scaled to inflation, and payments depend solely on other factors.
- "Annuities for Dummies"; Kerry Pechter ; 2008