Annuity
A financial contract with an insurance company converting a lump sum into a stream of regular income payments.
What is Annuity?
An annuity is a contract between an individual and an insurance company in which the individual makes a lump-sum payment (or series of payments) in exchange for regular disbursements beginning either immediately or in the future. Annuities are primarily used for retirement income. They come in many forms: immediate annuities begin paying within a year; deferred annuities accumulate funds before beginning payouts. Fixed annuities guarantee a set interest rate; variable annuities invest in sub-accounts tied to market returns; indexed annuities credit returns linked to an index like the S&P 500. The unique feature of annuities is the ability to generate income that cannot be outlived — longevity insurance against the risk of depleting savings.
Example
A 65-year-old retiree uses $300,000 from their IRA to purchase a single-premium immediate annuity (SPIA). The insurance company calculates, based on their life expectancy, that they will receive approximately $1,600 per month for life. If they live to 90, the total payout exceeds $576,000 — far more than the $300,000 invested. If they die at 70, the insurance company keeps the remaining funds (unless a joint-life or period-certain option was selected).
Source: Investopedia — Annuity