Annuities are a popular way both to invest and to save for retirement. The idea behind an annuity is that by combining a life insurance policy with investment advantages and tax deferred status, you arrive at a singularly effective savings vehicle. However, annuities are not always the risk free, guaranteed financial products they are perceived to be. There are different types of annuities and they carry with them different potential advantages, and disadvantages.

The two basic types of annuities are fixed and variable annuities. Let’s take a look at each of them in brief:

Fixed Annuities

Fixed annuities are one in which the money that an individual, often a retiree to be, deposits into an account is guaranteed to be paid back at a specified later time in a regular fashion that does not change. The phase during which an individual deposits money into the annuity is called the deferral phase, and the phase during which it is paid back is called the annuity phase. This is essentially based on the idea of a life insurance policy – the company offering it agrees based on the principal invested to make regular payments back to the policy holder either for a specific term of years, or sometimes for the remainder of the individuals life.

Variable Annuities

A variable annuity is somewhat different. In this case, the funds deposited into the annuity are invested in sub accounts in a manner similar to mutual funds. This being the case, the rate at which the money is redistributed as per the contract is allowed to vary based on the performance of the investments. Often these annuities are immediate – in other words, there is no lengthy deferral period before the policy holder/investor starts receiving payments. They may begin as soon as the policy is opened, or when the investments begin to perform.

The basic differences between fixed and variable annuities concern factors such as risk, time, and fees. A fixed annuity is a much less risky proposition. There is a guarantee in writing that the amount of the policy will be paid back with regularity and there is little to be concerned about except the reputability of the company. Especially if the term of the annuity is for the life of the policy holder. With fixed annuities that are only for a certain period there may be a concern that someone could outlive the length of the policy and thus no longer receive payments, but that is about it.

Are Variable Annuities worth the risk?

Variable annuities have both greater risk and greater fees associated with them. Since the funds in the policy are invested, they can either increase or decrease in value, possibly very sharply, in a short period of time. This is clearly only an advantage of the investments perform well. There are obviously situations in which you want or expect volatility and ones in which you do not. It is in addition more expensive to hold such a policy because the brokering fees must be added in.

On the up side, if the investments do well, variable annuities can be much more lucrative than fixed ones. The question obviously is which annuity type is right for specific people and specific situations. Once an understanding of annuities is gained, this becomes fairly easy to determine.