Don’t Miss the Boat: Understanding Annuity Basics

June 1, 2018

Imagine this scenario:

You’re on a boat that you have owned for years, sailing across blue waters with not a care in the world. Suddenly, your engine just dies and the sails fall. Previously calm, blue lake waters have turned to grey.  As you frantically try figure out how you could spur the engine to make it to shore, you hear a wonderful sound: a working boat engine. You look over your shoulder and your heart sinks—it’s a red boat. Red is, as everyone knows, the worst color ever. They pull up and offer you assistance, but of course, you decline. Far better stuck in the middle of the lake than in a red boat, right? So how is any of this related to an annuity?

Most of you probably read that scenario and thought the ending made no sense. And,  you’re right, it doesn’t. But that scenario is something that I see play out time and again from retirees when it comes to annuities. They come in wanting conservative growth and no risk to principal, with a way to use the money for future expenses (logical desires for any retiree’s portfolio.)


As soon as they hear the word annuity, their guard goes up. Most of the time it’s not even a specific cause. It’s just the fact it’s an annuity. They’re under the assumption that word means “bad investment idea”. In other words, even if it’s the perfect solution to their situation, it’s a red boat and that means they’d rather stay stuck in a watery dilemma.

There is good news!

The good news is that annuities aren’t something you have to cast off. Typically, once we walk clients through how annuities functions, most understand just how useful they can be in retirement planning. Understanding what an annuity is and what different types exist is an essential step to seeing if they have a place in your retirement game plan.

The SEC defines an annuity as a contract between you and an insurance company that is designed to help with long-range goals. You agree to purchase an annuity for a set amount, and in return, the insurance company agrees to make payments to you in the future, either by lump-sum or periodically (depending on your choices.)

Annuities can break down into 4 Categories.

  • Immediate Annuity  functions like a pension. You pay a premium that will guarantee a certain payment amount, typically in monthly installments, for either a specified amount of years or for the entire life of the owner.


  • Fixed Annuity serve a similar function as a simple Bank CD. You’ll pay a premium in return for a promise from the insurance company that your account will grow at a certain rate for a specified period of time. For example, if I purchase a $100,000.00 policy and they promise 5% growth for the next five years, I have the assurance of knowing no matter how crazy the market might get, my account is going to earn 5%.


  • Variable Annuity are one of the more controversial and complicated products because the difference is that a variable annuity can grow—or take a loss. Sub-accounts are held within the annuity (sort of like mutual funds), and your contract grows based on the success of those sub-accounts. On the other hand, this function means that while you might see higher growth than someone in a fixed annuity, you might also see loss just as you would in a regular stock market account.


  • Indexed Annuity is a hybrid of both fixed and variable annuities. Like a variable annuity, the growth method allows you to follow some of the major indices in the market (S&P500, Dow Jones, Nasdaq, etc) and your contract captures some of the growth from your chosen index during the year. Similar to a fixed, it also guarantees your contract value won’t fall below the initial premium.


While the individual products themselves have a lot of ins-and-outs that your advisor can help break down for you, understanding annuity basics ultimately help you decide if an annuity is right for your retirement goals. Remember how silly the red boat situation sounded? Don’t let yourself play out that same scenario for a product that can potentially get your retirement plan back to shore.