How Does An Annuity Work?

An annuity is a contract between a provider and an investor that allow the former to get paid a certain amount each month. Usually, an insurance company offers annuities for employees and retirees. In the contract, the recipient is supposed to be able to receive regular monthly payments without any restrictions. Annuity payments are often tax-deductible. However, some contracts stipulate that the payments will not be reduced unless and until the policy holder dies.


Annuities are generally designed in different ways. For example, in an indexed annuities, the investment is based on the rates of increase in the stock market. In a fixed annuities, the investment is secured by a specific asset. Indexed annuities, in general, pay out a fixed amount at the beginning, during the life of the policyholder, and then the payments are deferred until such time that the investment returns to normal levels.

An annuity usually has a fixed or guaranteed interest rate and a fixed or guaranteed payment value. The value of the contract usually depends on the amount of money that is invested in it, as well as the investment options that are available to the policyholder. The present and future value are often considered in an indexed annuities, whereas fixed annuities have a fixed interest rate and a fixed or guaranteed payment value.

In a fixed annuities, the payment value is guaranteed regardless of inflation. This means that a fixed annuity will not lose value, even if the stock prices decline. Usually, the interest rate on a fixed annuity is usually fixed, as well. However, some annuitants may be eligible for an increase in the payment value. In such case, they would have to pay an additional amount for the additional cash value. However, this additional payment is normally very small in comparison to the value of the interest that is earned on the principal amount of the fixed annuities.

If the amount of an indexed annuity is indexed, the payment value is increased automatically when the value is increased. If the payment value is guaranteed, there is no need to pay extra money each month to increase the amount that the provider receives. However, if the payment is fixed, there is a risk that the value will decrease as the value increases if there is a rise in the market value.

On the other hand, the annuities with guaranteed payments are known as variable annuities. This means that the payments, at the time of death of the policyholder, are calculated based on the current market value. However, if the interest rates rise, then the premiums are increased based on what the payments would be at the time of the death of the policyholder, even if the interest rate has declined during the life of the policy.