We posted various articles on annuities. Here is one attempt to explain what are the different types of annuities that exist today in US. Although I haven;t invested in annuities and probably will not do unless I get some compelling reasons to do otherwise. I always get perplexed if annuities are really smart investment option.
Annuities are insurance products that pay out income, and often used as part of a retirement plan. Investors who want to receive a secure income in retirement prefer annuities.
How an annuities work: you put money in the annuity, and it then pays you back in future dates. The income you receive from an annuity can be paid out in monthly, quarterly, annually installments or as a lump sum payment. The size of your payment is determined by the duration of your payment period.
You can also choose to receive payments for the rest of your life, or for a defined number of years. The amount you receive depends on which option you go for: a guaranteed fixed annuity payout or a variable annuity based the performance of your annuity’s principal investments.
- Premium Payments
- Payout timing
- Investment Options
- Single Premium
- Single premium annuities need a single initial investment at the beginning of the contract, which is possible for any type of annuity, the most common type of single premium, is a single premium immediate annuity (SPIA).
- Flexible Premium
- You may also contribute your annuity payments over time – the same way other retirement accounts are funded. This is called a flexible premium annuity/ variable annuity; you can make monthly or yearly payments depending on the insurance company.
- Immediate/Income Annuities
- Income annuities allow you to change a large amount of money into regular income payments, which may commence within a year. They can last for a fixed period say 10 years, or can be for life. The annuity payout amount depends on the lump-sum investment and the expected number of installment payments.
- Deferred Annuities
- Income payments are delayed for some time while the premium grows. These types of annuities include; Variable fixed and indexed annuities. Upon retirement or maturity, the contract sum value is either cashed in as a lump sum or converted to an immediate annuity through “annuitization.”
A fixed annuity guarantees a fixed interest rate through the accrual phase. Investors prefer it for its perceived safety and assurances. But this safety comes at a cost, like:
- Rate of return is much lower than other investment options.
- Interest rate is not permanent. It can be reset at the end of pre-determined periods/terms which maybe as short as one year.
- Insurance company invests your premiums in order to earn profits then it pays fixed annuity owners. The difference is their profit.
This type of annuity is preferred more than the other types of annuity. You may invest funds in fixed accounts, which resemble mutual fund investments sold by insurance companies. Variable annuities have the highest probable capital returns, but also attract the highest volatility charge very high annual fees.
Variable Annuities have some advantages, including:
- Interest is not taxed unless the funds are withdrawn in lump sum.
- You can purchase optional benefits (riders) like lifetime income options, as guaranteed minimum withdrawal benefits.
- Stock market participation, investors choose which funds in which to invest.
Equity-indexed annuities, also known as indexed annuities participates in stock markets and used as yardsticks to calculate returns. They Offer minimum and maximum interest rates based on stock market index returns. Meaning, the principal has some growth potential. Generally; these funds can outperform bonds, but cannot outdo stocks. They attract higher surrender fees and longer surrender periods. They also offer bonuses that are subject to longer surrender periods.
Annuities can be purchased from an insurance company or in national retirement authority funds. You can pick an annuity based on your immediate needs and the interest it will earn over long periods. Factor in the pros and cons of all the annuities before making a decision so that you pick the best.
Let me know if you want me to cover deeper in to annuities. Here are some articles on annuities that I have written in the past, for your reference.
- What to do With your Annuity Investment in Retirement Plan?
- Some Do’s and Don’ts of Annuity Investment