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Annuity
The Main Types of Annuities
How to choose between Fixed and Variable, Immediate and Deferred.
Key Takeaways
- A fixed annuity guarantees payment of a set amount for the term of the agreement. It can't go down (or up).
- A variable annuity fluctuates with the returns on the mutual funds it is invested in. Its value can go up (or down).
- An immediate annuity begins paying out as soon as the buyer makes a lump-sum payment to the insurer.
- A deferred annuity begins payments on a future date set by the buyer.
What is an Annuity Contract?
An annuity contract is a written agreement between an insurance company and a customer outlining each party's obligations in an annuity agreement. Such a document will include the specific details of the contract, such as the structure of the annuity (variable or fixed); any penalties for early withdrawal; spousal and beneficiary provisions, such as a survivor clause and rate of spousal coverage; and more.
Key Takeaways
- Annuities are often complicated financial vehicles designed to provide lifetime income.
- A beneficiary can inherit an annuity contract upon the annuitant's death.
- An annuity contract can encompass up to four people--issuer (usually an insurance company), the owner of the annuity, the annuitant, and the beneficiary.
- Often the owner and annuitant can be the same person.
Types
Fixed Annuity
Immediate Payment Annuity
Immediate Payment Annuity
A fixed annuity is a type of insurance contract that promises to pay the buyer a specific, guaranteed interest rate on their contributions to the account. By contrast, a variable annuity pays interest that can fluctuate based on the performance of an investment portfolio chosen by the account's owner. Fixed annuities are often used in retirement planning.
Key Takeaways
- Fixed annuities are insurance contracts that pay a guaranteed rate of interest on the account owner's contributions.
- Variable annuities, by contrast, pay a rate that varies according to the performance of an investment portfolio chosen by the account owner.
- The earnings in a fixed annuity are tax deferred until the owner begins receiving income from the annuity.
Immediate Payment Annuity
Immediate Payment Annuity
Immediate Payment Annuity
An immediate payment annuity is a contract between an individual and an insurance company that pays the owner, or annuitant a guaranteed income starting almost immediately. It differs from a deferred annuity, which begins payments at a future date chosen by the annuity owner. An immediate payment annuity is also known as a single-premium immediate annuity (SPIA), an income annuity, or simply an immediate annuity.
Key Takeaways
- Immediate payment annuities are sold by insurance companies and can provide income to the owner almost immediately after purchase.
- Buyers can choose monthly, quarterly, or annual income.
- Payments are generally fixed for the term of the contract, but variable and inflation-adjusted annuities are also available.
Deferred Annuity
Deferred Annuity
Deferred Annuity
A deferred annuity is a contract with an insurance company that promises to pay the owner a regular income, or a lump sum, at some future date. Investors often use deferred annuities to supplement their other retirement income, such as Social Security. Deferred annuities differ from immediate annuities, which begin making payments right away.
Key Takeaways
- A deferred annuity is an insurance contract that promises to pay the buyer a regular income or a lump sum of money at some date in the future. Immediate annuities, by contrast, start paying right away.
- Deferred annuities come in several different types—fixed, indexed, and variable—which determine how their rates of return are computed.
- Withdrawals from a deferred annuity may be subject to surrender charges as well as a 10% tax penalty if the owner is under age 59½.
Variable Annuity
Deferred Annuity
Deferred Annuity
A variable annuity is a type of annuity contract, the value of which can vary based on the performance of an underlying portfolio of sub accounts. Sub accounts and mutual funds are conceptually identical, but sub accounts don't have ticker symbols that investors can easily type into a fund tracker for research purposes. Among annuities, variable annuities differ from fixed annuities, which provide a specific and guaranteed return.
Key Takeaways
- The value of a variable annuity is based on the performance of an underlying portfolio of sub accounts selected by the annuity owner.
- Fixed annuities, on the other hand, provide a guaranteed return.
- Variable annuities offer the possibility of higher returns and greater income than fixed annuities, but there’s also a risk that the account will fall in value.
Annuity vs. Life Insurance
Annuities and life insurance are both contracts between insurers and policyholders. Both offer tax-deferred growth, and, similar to life insurance policies, annuity contracts may offer death benefits to beneficiaries. But that’s where the similarities end. Although life insurance policies do not provide lifetime income, you can convert life insurance to an annuity, tax-free.
Annuities are not life insurance policies. They are, in fact, designed to serve the exact opposite purpose. Whereas life insurance guarantees income in the event of your death, an annuity guarantees income in the event that you live longer than you expect to.
Which Solution Is Right for You?
The short answer is that a financial strategy that includes annuities and life insurance may be right for you. Your long-term plans for your money and your lifestyle will determine whether one or both products will help you to achieve your goals now and in your retirement years.
There are two types of annuities — deferred and immediate. There are three subsets of deferred annuities, including fixed annuities, variable annuities and fixed-index annuities.
All types of annuities grow on a tax-deferred basis.
Just as there are two basic types of annuities, there are also two basic types of life insurance products — temporary and permanent.
Risk Tolerance
Risk tolerance refers to the level of risk a person is willing to endure with their financial portfolios. Annuity owners and investors can be conservative, moderate or aggressive with their money, depending on their comfort level with balancing risk and reward. Stock market volatility influences the values of different types of annuities to varying degrees. Certain annuities have a greater potential for gains or losses based on the stock market’s performance.
When choosing an annuity, it’s important to select a product that best aligns with your level of risk tolerance at that specific point in your life.
Annuities are insurance products that are best suited for people with a lower risk tolerance or those who want to balance their portfolios with a low-risk, low-return income option. But among the available annuities, buyers will find a range of features and products along the risk-tolerance spectrum.For example, variable annuities are riskier than fixed and indexed annuities and don’t automatically offer premium protection, but they can provide a fixed income stream for a guaranteed period of time.
Therefore, variable annuities are generally better for people who have a higher risk tolerance and are seeking an income stream in retirement to supplement Social Security.