Annuities are retirement planning tools that have two separate phases; the accumulation phase and the annuitization phase. During the first phase you invest money with an insurance company or an investment firm. Over the years you develop a lump sum which grows based upon your deposits and the rate of return.
Annuities grow tax-deferred until money is withdrawn. Upon withdrawal, funds are taxed at your current tax rate. Additionally, there is a 10% federal penalty if you withdraw funds before you reach age 59 ½. Annuities are meant to be long term retirement based investments ideally used by those who have already contributed the maximum allowed to their 401(k), 403(b) or IRA. Those retirement accounts have much lower fees than those associated with an annuity.
The annuitization phase begins when you start to withdraw money from your savings. These payments are regular and can be set according to your needs, for example monthly or annually. The payments continue until you pass away.
Since it is increasingly common to depend wholly upon such annuity payments upon retirement, it behooves the investor to start early and invest as much as possible during their working years. The greater the total investment the higher annuity payments will be, and the longer they will last.
Many annuities have a death benefit, although it is unlike those you expect from a life insurance policy. If the annuitant passes away before they annuitize their fund, the beneficiary receives either the amount the annuitant paid into the fund or the current value, whichever is greater. This offers them a bit of additional insurance against a poorly performing investment.