An annuity is a contract between you and an insurance company. You give the insurer money — all at once or over time — and in return it agrees to grow that money, pay you income, or both. Understanding how annuities work comes down to three things: the two phases of the contract, how your money earns interest, and the rules for getting money out.
The two phases
Most annuities have an accumulation phase and a payout phase. During accumulation, your money grows tax-deferred, meaning you don't pay income tax on the growth until you withdraw it. During the payout phase, you can take withdrawals, or turn the account into a stream of guaranteed income for a set number of years or for life.
How your money earns interest
With a fixed annuity, the insurer credits a set interest rate for a set period. With a fixed indexed annuity, interest is linked to a market index such as the S&P 500, with limits. For example, if a contract has an 8% cap and the index rises 12% for the year, you'd be credited 8%. If the index falls 10%, you'd be credited 0% — you don't lose money because of the market. (These numbers are only an illustration; actual caps and participation rates vary by contract and can change.)
Getting money out
Annuities are built for the long term. Most contracts have a surrender period, often several years, during which withdrawals above a set free amount trigger a surrender charge. Withdrawals before age 59½ may also face a 10% federal tax penalty on top of income tax.
Who annuities tend to fit
Annuities often make sense for people who are nearing or in retirement, want part of their savings protected from market drops, and value predictable income. They are usually a poor fit for money you may need in the next few years.
Next step
The right annuity depends on your age, your other savings, and what you want your income to look like. Book a no-pressure conversation and we'll walk through it together.
Guarantees are backed by the claims-paying ability of the issuing insurance company. Annuities are not FDIC insured. Hudson Agency does not provide tax or legal advice.