What is an annuity?
Put very simply, annuities are an insurance product designed to secure a fixed income stream, either immediately or in the future.
Here’s how annuities work: when you purchase an annuity contract from a financial institution, you either provide a lump sum upfront or make periodic payments. This is called the accumulation phase. The cash you contribute to your annuity is invested into an annuity fund, gaining value over time—much like how a 401(k) or 403(b) account works.
However, instead of withdrawing your total accumulated annuity fund as a lump sum, as you might with a 401(k), you will start to receive regular, fixed payments, beginning at the time you agreed upon when signing your contract. This is called the annuitization phase.
You do not have to be at retirement age to receive your annuity payments, but people typically purchase an annuity with retirement in mind because it can help assuage fears of outliving your savings. But annuities are not to be confused with pensions, a benefit an employer may offer that requires you to reach retirement age before you begin to receive payments. Pension benefits are becoming increasingly uncommon, so annuities are an appealing option to those who want to receive regular payments in retirement.