Final answer:
Annuities are financial products designed to provide a fixed annual income, which is vital for retirees requiring stable income streams. They are considered safer than other riskier investments but might yield a lower total return. Retirement annuities often come with special tax status and are part of employer-provided retirement plans.
Step-by-step explanation:
An annuity is designed to provide a secure, fixed sum of money paid to an individual each year. This financial product is particularly beneficial for retirees who need to ensure a steady income stream that will last their entire retirement. Unlike pensions, which are often criticized for remaining nominal and not keeping pace with inflation, annuities offer a defined benefit that could potentially be structured to adjust for inflation, safeguarding the retiree's purchasing power over time.
Companies create pension funds to accumulate savings to pay out these annuity-like fixed annual payments to retired workers. While annuities can be considered a safer investment option with fixed payouts, it should be noted that they might offer less total income compared to riskier assets like stocks or dividend-paying shares.
Many employers offer annuities as part of their retirement plans, and these could be purchased through a lump sum payment or gradual contributions over time with special tax status. The fundamental law of insurance states that payments into any such plan must cover the individual's claims, administrative costs of running the company, and allow for firm's profits. Thus, when considering retirement planning, it's vital to balance the tradeoffs between risk and the rate of return.