When an employee retires after several years of work, the employer offers monetary retirement benefits such as a cash balance plan or pension.

Let us consider Nancy, who has retired from work. She likes to invest her retirement package in something that can yield regular income. She invests her money in an insurance company by signing a mutual agreement between her and the company. According to the agreement, the insurance company makes periodic payments to her. That is, the insurance company ‘sells’ an annuity to Nancy. Webster’s Dictionary defines an annuity as `a sum of money payable yearly or at other regular intervals.’

Sometimes, even people who have yet to retire go in for purchasing annuities as a means of saving for their ‘rainy days.’

There are basically three types of annuity payments: fixed, variable and equity-indexed. Fixed annuities are annuities in which the rate of return to the buyer remains constant. Suppose Nancy opts for a fixed annuity for a 20-year time period [known as the ‘surrender period’]. The insurance company assigns a rate of return and lets Nancy know it in advance. This rate of return remains unchanged during the entire 20 years. Because she knows how much she’ll draw every month, it’s much like a monthly salary. But she cannot withdraw any part of her invested amount during the surrender period, without some penalty. Security in a fixed annuity is linked to the financial standing of the insurance company.

Fixed annuities can involve a definite surrender period, as in the above example, or an indefinite period, such as Nancy’s lifetime.

Suppose Nancy buys a variable annuity instead. A variable annuity involves a range of investment options, and the rate of return is tied to internal mutual funds. As these funds depend on financial market conditions, they can go up or down, thereby making the rate of return unstable.

If Nancy goes in for an equity-index annuity, the rate of return can vary depending upon changes in an equity index, such as the S&P 500 Composite Stock Price Index. According to the US Securities and Exchange Commission, she may even lose money, especially if she cancels the annuity early. This is because equity-indexed annuities are complicated and may contain several features that can affect the rate of return.

Annuities can be purchased by single payments or flexible payments. They can also be purchased as immediate annuities, where the yield is earlier, or as deferred annuities, where it is delayed.

Annuities are not insured by the FDIC and are not bank guaranteed. However, they are one of the most popular sources of regular periodic income to most people who are spending their post-retirement years.