What Does an Annuity Accumulation Period Look Like?

As you plan for retirement, you may consider buying an annuity. After all, who doesn't want a guaranteed stream of income when they retire? But there are some things you should know about these investments before you sign on the dotted line, including understanding the accumulation period. If you're considering an annuity, a financial advisor can help decide whether this investment option is right for you.

What Is an Annuity?

An annuity is a financial contract with an insurance company that's designed to provide a guaranteed income stream in retirement. You can choose to fund your annuity either with a lump sum or with a payment plan that allows you to fund the annuity over time. In return, you receive payments from the insurance company on a schedule determined ahead of time.

Annuities can be fixed or variable. Fixed annuities offer guaranteed payments over the length of the contract, intended to return the principal of the annuity plus a fixed amount of interest. Variable annuities also return the principal on a set schedule, but the interest is based on the annuity's underlying investments. As a result, the interest can vary, making variable annuities a bit riskier than their fixed counterparts.

Annuities can also have different terms or lengths of time over which they will produce payments. Some will be for a set number of years – say 20 or 30 – and some will last until your death. You can also set up your annuity so it starts paying out immediately or choose to defer those payments until a later date, such as retirement.

What Is an Accumulation Period?

The accumulation period is simply the time when you are making payments to the insurance company. If you fund your annuity with a lump sum, the accumulation period also covers the period of time wherein the annuity is increasing in value.

The accumulation period ends when the annuity starts paying out per your contract. You may receive your payment as a lump sum, but it's more common to receive a series of payments over the schedule you determined when you created the annuity.

How Do Accumulation Periods Work?

When you go to buy an annuity, you will determine whether to fund it with a lump sum or with payments that are made over time. You'll also decide if you want the annuity's payments to begin as soon as the annuity is fully funded or if you want to defer them until a later date.

If you opt to fund your annuity with a payment plan and defer those payments, the accumulation period will begin when you start making payments. It will continue when you have finished making all the necessary payments but are still deferring the annuity's payments. You might fund it with a lump sum and opt to take payments immediately, in which case the accumulation period would be brief.

Annuities can be a great way to both save for retirement and turn your existing savings into a steady income stream. In the former case, annuities allow you to accumulate interest and earnings in a tax-deferred account. That means you won't owe taxes until you start getting payments from the annuity.

Just keep in mind that there are risks associated with annuities. Annuity payments stop when you die, so you run the risk of never recouping your principal investment if you don't live long enough.

What an Annuity's Accumulation Period Might Look Like

If you decide to set up an annuity, the accumulation period might look something like this. You purchase an annuity with a set payout structure. You might agree to invest $500 a month for 15 years and take payments when you turn 65.

The accumulation period in this case would begin when you make your first payment to the insurance company. It would end when you turn 65 and start taking payouts from the annuity. The accumulation period will be clearly delineated when you open the annuity, so it won't come as a surprise. You will - or should - understand it all upfront as part of the contract you agree to.

Bottom Line

While an annuity's accumulation period is relatively easy to understand, choosing which one works for you might be a little more complicated. Do your research and consider talking to an expert financial advisor to understand how an annuity can fit into your larger retirement plan before you make a purchase.

Retirement Planning Tips

• Finding a financial advisor now can really help you save the most for your retirement. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

• Don't have a 401(k) or IRA? These accounts are crucial for retirement planning. Not only that, but you'll want to maximize your contributions to your accounts as best as you can. Just be aware of the legal contribution limits for retirement accounts like these.

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