How do Annuities Work

How do Annuities work. Understanding annuities: the most important concepts with regard to how annuities work that you must know.

How Annuities Work

Annuities are contracts that you sign with insurance companies, whereby you agree to make lump-sum payments in exchange for a guaranteed minimum rate of return and tax-deferred earnings.

Understanding Annuities: Annuitizing

Annuitizing is an exchange where you agree to surrender your initial investment entirely in order to receive a fixed monthly income from the insurance company for life (or for up to five or ten years after your death). You will give up your principal investment to the insurance company entirely.

What determines your monthly payment? Your age, the amount of your original investment, the current level of interest rates, the type of annuitization policy you have chosen.

Generally, annuitizing will only make sense if the interest rates are extraordinarily high. Otherwise, monthly withdrawals will make much more sense.

Understanding Annuities: No Load Annuities

No load annuities do not carry any surrender chargers, commissions or sales charges. A good example of an insurance company offering no load annuities would be The Vanguard Group.

Understanding Annuities: Mortality Fee

This is a hefty fee charged by the insurance companies in exchange for guaranteeing you against any losses. This fee is typically charge at 1.3 percent per annum. With variable annuities, insurance companies guarantee that upon the annuitant’s death, he or she would be able to get back either the full amount of the original investment or the value of the account then, whichever is greater.

However, this mortality fee in essence does not benefit the annuitant. If you do need the money at any point in time before you die, you will still only be able to get back your balance then. The insurance companies’ guarantee only applies in the case of death.