What is the purpose of an annuity?

An annuity is a financial tool primarily designed to provide individuals with a steady, reliable income, often during retirement. The main purpose of an annuity is to ensure that you don’t outlive your savings, offering peace of mind by converting your investments into a predictable income stream. Here are the key purposes of an annuity and why it can be a vital part of your financial plan:

1. Providing Lifetime Income

One of the primary reasons people purchase an annuity is to secure a lifetime income. Annuities are structured to provide regular payments for a set period or for the rest of your life, helping you avoid the risk of outliving your savings. This is particularly important for retirees who need to plan for an unknown lifespan, ensuring that they have consistent income even if they live well into their 80s or 90s.

Why It Matters: With increasing life expectancy, the concern of outliving savings has become a real challenge. Traditional retirement income sources like pensions or Social Security may not be enough. Annuities help fill that gap by offering guaranteed income for life, regardless of market conditions.

2. Tax-Deferred Growth

During the accumulation phase of an annuity, any interest, dividends, or capital gains that your money earns are allowed to grow tax-deferred. You won’t pay taxes on the earnings until you start withdrawing the funds. This allows your investment to compound over time, which can lead to greater growth compared to taxable accounts where earnings are taxed annually.

Why It Matters: The tax-deferred nature of annuities can help your savings grow faster. If you’re not using the money immediately and are looking for long-term growth, an annuity can be a smart option because your gains aren’t reduced by yearly taxes.

3. Supporting Retirement Planning

Annuities play an important role in retirement planning by offering financial security. While other retirement accounts (like IRAs or 401(k)s) are subject to market fluctuations, annuities provide a guaranteed income stream, regardless of how the market performs. By purchasing an annuity, retirees can ensure that at least part of their income is secure and predictable, even during economic downturns.

Why It Matters: The stock market and other investments can be volatile, especially during retirement when there’s little room for loss. An annuity offers a safe, stable source of income to cover essential expenses, giving retirees confidence and peace of mind.

4. Customizable to Your Needs

Annuities are flexible and can be tailored to suit different financial needs and goals. You can choose how you want to receive payouts, whether for a set number of years or for the rest of your life. You can also decide when to start receiving income—immediately or after a deferred period. Additionally, there are options to add features such as spousal benefits (so payments continue to a surviving spouse) or death benefits (so beneficiaries can receive a payout if you pass away before the annuity matures).

Why It Matters: The ability to customize an annuity means it can fit a wide range of financial situations. Whether you need immediate income or want to delay payouts to a future date, annuities can be designed to meet your specific retirement goals.

5. Providing a Hedge Against Longevity Risk

Longevity risk refers to the risk of living longer than expected, which can lead to outliving your savings. Annuities address this risk by offering lifetime income. Unlike other retirement assets that may eventually run out, an annuity ensures that payments continue for as long as you live. This can help cover healthcare costs or other unforeseen expenses that may arise in later life.

Why It Matters: Annuities provide a buffer against the uncertainty of life expectancy. By securing lifetime income, you protect yourself against the financial burden of unexpected long-term living expenses, including healthcare or assisted living costs.

6. Legacy and Estate Planning

Some annuities can be used as part of a legacy or estate planning strategy. Certain types of annuities include death benefits, which allow your beneficiaries to receive any remaining balance or payments after your death. This ensures that your loved ones are financially protected even after you pass away.

Why It Matters: If you’re concerned about leaving a financial legacy for your family, annuities can be structured to provide income or payouts to your beneficiaries. This ensures that your money continues to benefit your loved ones in a structured and tax-efficient way.

7. Risk Management and Peace of Mind

Annuities offer an additional level of security by protecting you from some of the financial risks associated with retirement, such as market volatility and longevity risk. Many annuities, especially fixed annuities, offer guarantees that help manage these risks, giving you peace of mind that you’ll receive income no matter what happens in the financial markets.

Why It Matters: Retirees face several risks, including the unpredictability of markets and outliving their savings. Annuities offer a safeguard against these risks, allowing you to enjoy retirement without constant financial worries.

Conclusion: Why Consider an Annuity?

The purpose of an annuity is to provide financial security, particularly during retirement, by ensuring a reliable income stream, offering tax-deferred growth, and managing risks like outliving your savings or market volatility. By including an annuity in your retirement portfolio, you can create a stable and predictable source of income that supports your long-term financial goals.

Annuities may not be right for everyone, but they offer valuable benefits for those seeking guaranteed income, risk management, and a customized retirement plan. As always, it’s important to consult with a financial advisor to determine whether an annuity is a good fit for your specific situation.