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What is an annuity?

Ric Edelman
Financial Health
The term annuity simply refers to a stream of income. Pensions and Social Security benefits, for example, are annuities. In the commercial marketplace, annuities are issued by insurance companies. You sign a contract with the insurer, promising to give the insurer “x” amount of money (your investment); in exchange, the insurer promises to give you “y” amount of money in return. When you receive it, how much you receive, and how long you receive it all depend on the contract you sign.

Ric Edelman is Founder and Executive Chairman of Edelman Financial Services, LLC, a Registered Investment Advisor, and an Investment Advisor Representative who offers advisory services through EFS and is a Registered Representative and Registered Principal of, and offers securities through, EF Legacy Securities, LLC, an affiliated broker/dealer, member FINRA/SIPC.

From the book The Truth About Money (Fourth Edition) by Ric Edelman. Copyright ©1996, 1998, 2000, 2004, 2010 by Ric Edelman, Edelman Financial Services LLC. Reprinted by permission of Harper Business, an imprint of HarperCollins Publishers.
The Truth About Money 4th Edition

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The Truth About Money 4th Edition

<p style="LINE-HEIGHT: normal; MARGIN: 0in 0in 0pt" class=MsoNormal><span style="FONT-FAMILY: 'Times New Roman','serif'; FONT-SIZE: 10pt">“A single source for what you need to know to put your financial house in order, an impressive piece of work, and very useful.”—Bob Clark, Editor-in-Chief, Dow Jones Investment Advisor<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" /><o:p></o:p><p style="LINE-HEIGHT: normal; MARGIN: 0in 0in 0pt" class=MsoNormal><span style="FONT-FAMILY: 'Times New Roman','serif'; FONT-SIZE: 10pt"><o:p> </o:p><p style="LINE-HEIGHT: normal; MARGIN: 0in 0in 0pt" class=MsoNormal><span style="FONT-FAMILY: 'Times New Roman','serif'; FONT-SIZE: 10pt">Ric Edelman, America’s most successful financial advisor, has revised and updated his classic personal finance bestseller to reflect the new global economic outlook. In his 4th edition of The Truth About Money, Edelman tells you everything you need to know about money—an essential, yet delightfully breezy and accessible, must-read manual for anyone who may have previously sought the financial wisdom of Suze Orman and Jean Chatzky. The Truth About Money is an indispensible guide to money matters from the man whom Barrons named the #1 independent financial advisor in the country.<o:p></o:p>
Maria Ferrante-Schepis
Financial Health
Annuities are intended to provide income for life, like a lifetime paycheck. Think of it like an insurance policy that guarantees you won’t outlive your money.

There are generally two types of annuities:
  1. The type that starts paying out immediately (called an immediate annuity)
  2. The type that pays out several or many years down the road (called a deferred annuity)
Immediate annuities are best for people who are a bit older and are ready to take income. Deferred annuities are best for people who don’t need the income now because they are still working and plan to retire sometime in the future. While deferred annuities are more common these days, it is helpful first to understand how the immediate annuity works.

Here is an example of how an immediate annuity works: Let’s say a 60-year-old man has $500,000 accumulated in savings from his working years, and would now like to retire. If he gives the insurance company that $500,000 and the insurance company invests that money in low risk investments. Then he would immediately get a monthly income of a fixed amount for as long as he lives.

The insurance company’s ability to provide the guaranteed income for life is based on the fact that many people are investing money with the insurance company. Some people will live beyond their life expectancy and others won’t. So those who die earlier than anticipated are basically paying for those who live long. While this may seem unfair to those who die earlier, some people are willing to take that chance because they are more concerned about making sure they can maintain their lifestyle if they live long.

Now, let’s get back to the more common type, which is the deferred annuity. With a deferred annuity, the payment is given to the insurance company many years before the income is needed. So let’s say you are a 47-year-old man and have accumulated $300,000 in savings from your working years to date. With a deferred annuity, you invest that money with the insurance company to let it grow before taking the income. The rate it accumulates at can be either fixed or might vary with the stock market directly or indirectly (such as with variable or indexed annuities). The more the rate is tied to stock market performance, the more risk you’d be taking with your money during that period of time. Hypothetically, let’s say by the time that 47-year-old man is 60, the amount grows to $500,000, and then the amount he can receive as an income is based on a $500,000 payment.

Annuities are the one investment vehicle intended to provide you with income for as long as you live. 

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Important: This content reflects information from various individuals and organizations and may offer alternative or opposing points of view. It should not be used for medical advice, diagnosis or treatment. As always, you should consult with your healthcare provider about your specific health needs.