Annuities are designed to produce safe, secure, retirement income for your entire life. In the old days, this was accomplished by annuitizing your savings. Basically, you would give up the value of your savings in exchange for a stream of income that you couldn't outlive. But, today we have many different types of annuities that allow for income streams and cash accumulation.
There are two classifications of annuities:
This simply refers to whether you are deferring the lifetime income or taking it immediately on purchasing the annuity. There are two phases of deferred annuities, an accumulation phase and a payout phase. The accumulation phase is the time you are accumulating cash value in the annuity, while the payout phase is when you are receiving income.
There are three different types of annuities:
The fixed annuity pays you an annual interest rate similar what Certificate of Deposits from banks do. The main advantage is that the interest rate is usually higher than what CDs offer. Your value never goes down so your principal is protected.
The variable annuity allows you to have sub-accounts that are tied into mutual funds. This means during the accumulation phase you still shoulder market risk. When the mutual fund goes down you suffer the same fate with your accumulation value. Also, variable annuities have a whole host of fees and expenses that fixed annuities and fixed index annuities don't incur. Most Variable Annuities have an income rider.
The fixed index annuity is the best of the annuities for retirement income. During the accumulation phase is gives you a variable interest credit tied to a stock index subject to a ceiling called a cap rate. It also never gives you a negative return, therefore protects your savings from going down. In addition to the accumulation it has an income rider that is designed to give high minimum return guarantees in exchange for initiating the lifetime income. By using this rider, you do not annuitize, therefore have the ability to pass on any remaining value to heirs or withdraw your remaining accumulation value later in life. This rider, with its high guarantees, simply makes this an ideal way to maximize your savings into lifetime income. Gains are locked in each year, you share in market upturns [with a ceiling], but don't share in market downturns and you have high minimum guarantees. You then can turn around and get guaranteed lifetime income when you decide it is the right time for your particular circumstances.
The bottom line is that by purchasing a fixed index annuity you eliminate market risk, get high guaranteed returns, and then guarantee an income stream you can't outlive.