An annuity is a contract with an insurance company. You make a lump-sum payment or a series of payments to the insurance company. Your money grows tax-deferred while it is in the annuity. Then, either immediately or at some point in the future, the insurance company starts making a series of payments to you at regular intervals.
There are many types of annuities. For example, with a fixed annuity, your money earns interest at rates set by the insurance company. With a variable annuity, the insurance company puts your premiums into a “separate account,” and you decide how the company will invest those premiums depending on how much risk you want to take.
How much you should invest in an annuity is primarily a product of how much you want the annuity to pay you. And that payout – also called a settlement option – depends on many factors.
For example, if you want a stream of income for life, you will have to estimate your life expectancy in order to determine how much to invest.
You will also have to estimate the expected returns from the annuity, which can be difficult if it is a variable annuity.
In fact, analyzing all these variables can be complicated. It’s wise to consult an advisor when considering how much to invest in an annuity.