Basically you give an insurance company a lump sum of money and choose how you want the insurance company to invest it and how to return your principle and gains to you or your heirs. Because they are issued by insurance companies they have tax benefits and other options unavailable in bank CDs. s Unlike CDs there is no FDIC guarantee, you have to look to rating agencies evaluation of the company to determine the companies safety. This rating is not a judgment of the annuity's merits.
A simple example is a contract to pay you a guaranteed rate for a year or more,after which it resets to some "competitive" rate. At the end of this accumulation period,say 5 years, you are allowed to take your money in a lump some or convert the total to an annuity. The Interest or gains will have accrued tax deferred. Taking money out early triggers severe penalties imposed by the insurance company. If you decide to annuitize the total amount either immediately or at the end of the accumulation period you will be offered many options such as a guaranteed lifetime payment to you and/or your spouse etc., wherein you pit your knowledge of family longevity against the insurance companies mainframe computer. Once annuitized your money is not yours, it's the insurance companies. Do not look for a refund.
Over the years many gimmicks have been added to annuities to insure insurance salesman don't starve. In particularly are variable guaranteed annuities in which it is inferred you can get most of the stock markets gains with none of the risk. Read the fine print, as they should have said in the mortgage business.

Annuities are medium-to-long term contract with an insurer/ annuity provider whereby the annuitant receives payments in exchange for contributions. That contribution can be a single premium or a series of premiums. Annuities work in a manner opposite to life insurance; whereas life insurance creates an estate, the annuity liquidates it.

The primary purpose of an annuity is to provide guaranteed lifetime income. Several annuities fall into the category of retirement annuities for this reason. Guaranteed lifetime income suggests that the insurer/ annuity provider guarantees payment of income for the rest of the annuitant's life. Qualified annuities are also used as tax shelters while others are merely used as income options for a limited term.

Annuities generally offer moderate interest rates or rates of return. However, there are often further guarantees in the form of base guaranteed rates. This means that regardless of market conditions, the returns of an annuity would not fall below a certain level. Some annuities are also backed by a statutory reserve fund, where the insurer can effectively meet their liability to annuity investors.

Annuities may or may not have an accumulation phase, but all annuities have a payout phase. In the case of Single Premium Immediate Annuities, the contribution is merely the amount invested. With deferred annuities, there are several factors that contribute to the size of the cash value (or the accumulated fund when the annuity matures):

a) Size and frequency of the contributions
b) Investment period
c) Rates of return/ Interest rates
d) Fees and expenses (especially where variable annuities are concerned)
e) Surrender charges and Taxes

The payout phase begins after the deferred annuity matures or the contribution is made. The amount that is paid is based on the size of the contribution/ accumulated fund, the annuitization rate and the settlement options chosen. The annuitization rate is based on the longevity risk of the annuitant, which is based on factors such as age and gender.

For example, a person may purchase an immediate annuity for $100,000 and would get $7,600 per annum for the rest of his/her life depending on the annuitization rate. An older person would receive more because of the shorter anticipated life span.

Types of annuities

There are various types of annuities available on the market. These can be split into the following dichotomies:

a) Fixed vs variable annuities
b) Immediate vs deferred annuities
c) Registered/qualified vs Unregistered/unqualified annuities

An annuity can be immediate and variable (or equity-indexed). In addition, there are deferred annuities that are fixed and that qualify for deferred taxation as well.

When an annuity matures, the annuitant usually has various settlement options from which to select. These include the following:

a) Straight life option: The annuitant is paid a lower payment for life

b) Straight life with refund option: If the annuitant dies before he is repaid the value of his contribution, this would be distributed to beneficiaries or his estate

c) Straight life option with period certain: The period certain applies to beneficiaries

d) Joint and last survivor: A nominated beneficiary continues to receive payments once the annuitant passes away.

Annuities are touted as the universal panacea to longevity risk, but not all annuities are equal. It would not be wise to invest all of your retirement savings in an annuity either. This is because the insurer takes your money, gives you something resembling the interest on it. Therefore, you give up ownership and control of your money to get returns from it.

Annuities strive to give more guaranteed payouts than you can expect from traditional retirement accounts. In exchange for giving the insurance company a monthly amount or large lump sum, you'll get a guaranteed pay out in retirement age. Think of them as pensions you create for yourself. There are three different types of annuities: fixed, variable, and indexed.

Fixed annuities are the most common. They lock in payouts at a fixed amount, providing retirees stable income for a period like ten years, or the rest of their lives. These annuities vary, you can buy them and establish the period of time you want them for, but of course, the cost will be higher the longer you need the pay out.

Indexed and variable annuities direct the money invested into market instruments. While they still guarantee minimum pay outs, the actual amount fluctuates throughout retirement, based on market returns. Indexed annuities see the money invested according to how the insurance company wants it done, while variable options give you more control over where your investment goes.