An annuity is a contract with an insurance company where you invest a lump sum or series of payments and receive regular disbursements, either immediately or at a future date.
Types
- Fixed: Guaranteed payout amount
- Variable: Payments depend on investment performance
- Indexed: Returns linked to a market index with a guaranteed minimum
Present Value Formula
PV = PMT × [(1 − (1+r)^−n) / r], where PMT = periodic payment, r = rate per period, n = number of periods.
Immediate vs. Deferred Annuities
An immediate annuity starts paying out right after you fund it, typically within a year — common for retirees converting a lump sum into guaranteed income. A deferred annuity grows tax-deferred for years before payouts begin, functioning more like a retirement savings vehicle with an optional income stream later.
Fees to Watch
Variable and indexed annuities can carry surrender charges (penalties for withdrawing early, often declining over 5–10 years), mortality and expense fees, and rider fees for optional guarantees. These costs can meaningfully reduce net returns compared to the headline rate, so reading the fee schedule matters as much as the payout terms.