With June designated as “Annuity Awareness Month” one can argue that many Americans are aware of the word “annuity” but may not understand how annuities actually work.
The annuity concept has been traced back to the Roman Empire. In return for their service, soldiers and their beneficiaries would receive annual payments for life known as “annuas,” the basis for the word annuity.
In the 17th century, these contracts were structured in the form of a “tontine” by feudal lords. Investors would contribute to a large pool of cash and receive annual payments for life. Upon death the payments ended and the remainder was redistributed among the group. If you were lucky enough to outlive everyone else in this arrangement you received the balance of the pool.
Despite their simple structure in the beginning, annuities have become increasingly sophisticated over time. When you invest in something, typically you assume all the risk. Since annuities are not investments, but are contracts with an insurance carrier, they allow you to transfer investment risk to the carrier. The risk you assume is that annuity payouts are subject to the claims-paying ability of the insurance company. (The only exception might be “variable annuities,” which are linked to a market index and rise–and fall—in value with the index.)
Recent innovations like fixed indexed annuities allow for growth in relation to an index, but the owner is protected from loss of principal if the index falls. With people living much longer and pensions quickly becoming a thing of the past, annuities can help provide income throughout retirement without the fear of running out of money. If you are considering the purchase of an annuity, it’s important to speak with a financial professional who understands them, and can explain the fine print of an annuity contract.
If you have any questions about annuities or how they work, call us here at Eric Scott Financial: 435.773.9444. We’re in Saint George, Utah.