5 Examples of Annuities in Action

Annuities are designed to eliminate one enormous risk of retirement — running out of money.

They're powerful because they're the only financial product that can offer guaranteed income until you die. They also come with significant tax benefits, and some annuities — fixed annuities — also provide guaranteed returns on your nest egg. 

However, annuities can sometimes feel intimidating and confusing. There are many types of annuities, each with different features and characteristics. It can be challenging to understand how each one works and their differences. 

In this article, we'll present five different annuity types and provide a clear example of each one and how it works.

1. Annuities from Lottery Winnings

A lottery annuity is an option available to lottery winners where, instead of receiving your winnings as a lump sum payment, you choose to receive it in the form of periodic payments over a set number of years. That helps you manage large sums of money more effectively, providing a steady income stream rather than a one-time windfall. 

Lottery Annuity Example

For example, imagine that Emily, a 35-year-old graphic designer, discovers she's won a massive $50 million jackpot in the state lottery. Emily opts for the annuity payment option, which breaks down her winnings into 25 annual payments of $2 million (before taxes). The first payment is made almost immediately after she claims her prize, with subsequent payments following every year on the anniversary of her winning.

The lottery annuity offers Emily:

• Financial stability. Emily likes that this option suits her lifestyle and helps with financial planning. She uses the payments to pay off her mortgage, invest in her retirement fund, and start a college fund for her two children. She also donates a portion to her favorite charity.
• Long-term benefits. Over the years, Emily enjoys the security of a guaranteed income. She doesn't have to worry about spending all her money at once or making high-risk investments. The annuity also helps her manage her tax liability more efficiently, as her annual income remains consistent.

2. Immediate Annuities

An immediate annuity is a financial product typically purchased from an insurance company with a single lump sum payment. Once purchased, the annuity starts paying out regular income almost immediately, usually within a year of purchase. 

Immediate annuities are particularly attractive to retirees or those very close to retirement because they immediately provide a guaranteed income stream. That helps to manage living expenses and offers financial security.

Immediate Annuity Example

For example, imagine Robert, a 65-year-old retired teacher, has recently received a $500,000 payout from his retirement fund. Concerned about outliving his savings and desiring a steady income, Robert approaches a reputable annuity company and puts his $500,000 in an immediate annuity. He chooses one that will start paying out monthly income within the next 30 days.

Robert enjoys the following benefits:

• Lifetime income. Based on the annuity contract terms and Robert's age, the insurance company calculates that he will receive $2,500 monthly for the rest of his life. How much the annuity pays is determined by factors such as the principal amount, Robert's age, the annuity's term, and current interest rates.

• Financial security. Robert's monthly annuity payments, combined with his retirement savings and social security check, allow him to maintain a comfortable lifestyle in retirement. 
• Immediate payments. Robert already had significant retirement savings. He preferred to start his annuity payouts immediately rather than first growing his retirement savings.

3. Variable Annuities

A variable annuity allows holders to allocate their purchase payments to various investment options, typically stocks and mutual funds. The value of a variable annuity and its income can fluctuate based on the performance of the chosen investment options. This means that the payouts may vary and are not guaranteed. 

Variable annuities are often chosen for their potential for higher returns and the opportunity they offer for investment customization, although they come with the disadvantage of being high risk.

Variable Annuity Example

For example, Sandra is a 50-year-old corporate executive who wants to diversify her retirement portfolio. She is looking for a riskier retirement investment option. After consulting with her financial advisor, Sandra decides to invest $200,000 in a variable annuity, allocating 70% in stocks for growth potential and 30% in bonds for stability. 

Her annuity offers several characteristics that she may find beneficial: 

• Variable growth. In some years, Sandra's annuity's value increases due to stock market gains, while in other years, it experiences only modest growth. In some years, her annuity even declines in value. 

• Variable income. At 65, Sandra annuitizes and starts receiving monthly payments. She was presented with a fixed or variable rate. She chose the variable rate, so unlike a fixed annuity, the amount varies each year based on the performance of her chosen investments. In some years, she receives higher payments when the markets perform well; in others, the payments are lower.
• Higher risk. Sandra's variable annuity provides her income generation and continued market exposure. It complements her other more conservative retirement investments, balancing her overall portfolio.

4. Fixed-Indexed Annuities

A fixed-indexed annuity is a type of annuity that offers a unique blend of features from both variable and fixed annuities.  

The returns on a fixed-indexed annuity are tied to the performance of a stock market index, like the S&P 500. Still, it also provides a guaranteed minimum interest rate, offering some protection against market downturns. 

Note that your earnings are typically subject to an upper limit or cap, meaning that while you can benefit from market gains, there is a limit to the maximum return you can receive in a given period.

Fixed-Indexed Annuity Example

For example, imagine Alex, a 55-year-old small business owner who is planning for retirement and looking for a balance between growth potential and security in his investments. He decides to invest $250,000 in a fixed-indexed annuity.

Alex's annuity is linked to the performance of the S&P 500 index. The insurance company offering the annuity specifies a cap rate of 10% and a guaranteed minimum interest rate of 0%.

The annuity has the following benefits:

• Yearly performance assessment. Each year, the insurance company assesses the performance of the S&P 500. If the index has increased, Alex's annuity earns interest based on this growth, up to the 10% cap. For instance, if the index grows by 8% in a year, Alex's annuity is credited with 8% interest.

• Protection from poor market performance. In a year where the S&P 500 index falls, Alex's annuity does not lose value. Instead, it earns the minimum guaranteed interest rate of 0%, protecting his principal from market downturns.

5. Fixed Annuities for Guaranteed Lifetime Retirement Income

A fixed annuity is a type of annuity that provides a guaranteed fixed rate of return on the principal investment. The insurance company guarantees the principal and a fixed interest rate, making it a low-risk investment option. 

Fixed annuities are popular among individuals seeking a stable and predictable income stream, particularly for retirement planning. The interest rate is determined at the outset and remains constant throughout the annuity's term, offering protection from market volatility and ensuring a consistent accumulation of value over time.

Fixed annuities are the only annuities that can guarantee growth.

Fixed Annuity Example

Linda, a 60-year-old retired nurse, wants to ensure a stable income during her retirement years. She has saved $300,000 over her career and decided to use it to fund a 5-year Future Fund fixed annuity from Canvas Annuity. At the time of purchase, the annuity offers a fixed interest rate of 6.5% per year (see here for current rates).

Linda lets her nest egg grow in the annuity for the entire five years. During this period, her annuity accumulates interest. The guaranteed minimum rate ensures that her money is not affected by fluctuations in the stock market or other financial risks.

• Converts to guaranteed income. After five years, the value of Linda's annuity has grown to over $411,000 from the interest accumulation. She decides to annuitize her contract, opting for a lifetime income stream. Based on the value of her annuity and the contract terms, she starts receiving regular monthly payments.
• Steady income in retirement. These payments provide Linda with a reliable source of income in addition to her other retirement funds like social security and personal savings. She uses this money to cover her living expenses, travel, and indulge in her hobbies.
• Peace of mind. One of the critical advantages for Linda is the peace of mind that comes with knowing she has a guaranteed income each month, regardless of market conditions. This security allows her to enjoy her retirement without the stress of managing a large sum of money or worrying about running out of funds.

Obtain Financial Security for Your Retirement

The examples above are hypothetical but illustrate how you can benefit from different annuities. 

Each one is designed for different circumstances. If you already have saved up your nest egg and want it to provide a steady source of income right now, an immediate annuity might be appropriate for you. If you still want to grow your savings and want your income to start in the future, a fixed annuity may be a better choice. 

As always, the best product for you depends on your needs. If you are looking for a safe way to grow your savings to feel secure in retirement, consider one of Canvas' fixed annuity products. Each one is simple to understand and has zero commissions, account charges, or fees. 

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