With so many investment options available, choosing the best ones to include in your portfolio can be overwhelming. An annuity is one of the least utilized investment strategies, even though it can offer guaranteed income and tax advantages. If you're new to annuities, this article is for you. We'll discuss what an annuity is, how it works, the different types, and how to calculate your potential earnings.

What Is an Annuity?

An annuity is an investment contract with an insurance company. You purchase an annuity for a set price or with monthly payments and receive a contract in return that determines when you'll begin receiving payments, how much each payment is, and for how long you'll earn. An annuity is most commonly used as a retirement tool because it can increase your monthly income.

Types of Annuities

It's important to note that different types of annuities determine how and when you'll receive payments. The most popular types of annuities include:

  • Fixed annuity: A fixed annuity pays you a set rate once your contract matures, regardless of market performance.
  • Variable annuity: A variable annuity pays you a return based on the market's performance.
  • Immediate annuity: An immediate annuity allows you to begin collecting payments right away.
  • Deferred annuity: A deferred annuity schedules your payments for a later date, usually once you reach retirement age.

Things To Consider When Investing in an Annuity

There are a few key things to consider when investing in an annuity, including:

Timing Is Important

As with any investment, timing your annuity purchase and the payout is important. Some annuities allow you to collect smaller monthly payments over a longer period, whereas others produce larger monthly payments for less time. Considering your retirement goals and lifestyle is a great way to decide how much and how often you want to receive annuity payments.

A Successful Investment Strategy Balances Risk

Successful investment strategies balance risk. The younger you are, the more room you have for riskier investments in your portfolio. As you near retirement age, you'll want to consider other, less risky options to balance your portfolio, like an annuity. This ensures you will have the funds you need for a comfortable retirement.

The Earlier You Invest, the Better

Pushing investing and retirement planning off when you're younger is common. You likely earn less at the beginning of your career, and if you're also paying student loans or raising a family, it can be difficult to find the funds to invest. However, when you factor in compounding interest, the earlier you begin investing, the better.

Annuities vs. Other Investment Types

You may be wondering how annuities pair up against other investment types. Here are some of the most important differences between the different investment types:

  • Annuity vs. retirement plans: An annuity offers guaranteed income, whereas a retirement plan is based on market performance. Retirement accounts also have maximum contribution limits.
  • Annuity vs. savings account: An annuity's interest rate and earnings are often much higher than a savings account's.
  • Annuity vs. certificate of deposit (CD): An annuity provides reliable monthly income, whereas a CD issues you a lump sum payment once your investment matures.
  • Annuity vs. stocks: Stocks have one of the highest potentials for returns but also carry the most risk. Stock market payouts are dependent on market performance.

How Much Does an Annuity Cost?

You can purchase annuities at different price points, and the great thing about annuities is that the transaction fees are usually less than other investment types. You can purchase annuities for as little as $2,500, but the average minimum cost is around $10,000 per contract.

Predicting Your Annuity Payouts

Your annuity earnings depend on how much you invest and the interest rate you earn. Other factors include your age at the time of purchase, how long you'll defer until receiving payments, and whether you have a joint or single-person annuity.

You'll need to review your annuity payout details, including your interest rate and length of payments, to predict your annuity earnings. Let's assume you purchase an annuity for $10,000 at a 3% interest rate with a monthly payout over ten years. Once you begin collecting, you'll receive monthly payments of $96.32, which calculates to $11,558.40, including compound interest earned. This calculation is based on a fixed annuity. Your earnings may vary if you purchase a variable annuity, as your returns fluctuate based on earned interest. An annuity calculator is a great way to compare options and predict earnings.

Annuities can be a great addition to your investment portfolio. They help balance risk by offering you guaranteed, reliable income. Learning to invest in an annuity can also help offset losses from riskier investments with the potential for greater returns.