The Different Types of Annuities

Annuities have become a very important part of many investors’ financial portfolio. There are many types of annuities with different levels of risks and returns on investments. In addition, annuities have many features that are similar to life insurance, thus giving an investor the desired diversification and benefits. Before making this type of investment however, you should consult with a financial advisor. An advisor will help frame your financial goals and values and determine how your financial portfolio is performing before diving into to this type of investment. Annuities are very complicated, with a variety of risks, fees and details to consider, so it's important to get the best possible advice out there before making any decisions.

Questions you should ask your financial advisor before investing in annuities:

  • What is the cost of the contract?
  • Is the cost paid in one lump sum or payments?
  • What is the minimum interest rate?
  • Is there an interest rate cap on my contract?
  • Is the interest compounded?
  • What are the surrender charges?
  • How long is the surrender period?
  • What is the term of the contract?
  • Is there an administration fee?
  • Is there a participation rate? If so, how long?
  • What economic indexing is used for the indexed annuities?
  • Can I make partial withdrawals of the principal and if so, are there additional charges or loss of interest?
  • What is the vesting rate if my contract includes vesting

Some key terms of annuities:

  • Annuitant- the investor of an annuity is considered an annuitant. The annuitant agrees to a contract with a life insurance company to receive periodic payments in exchange for an investment of a single large sum or payments in regular intervals.
  • Accumulation Period- the duration of the time an annuitant invest into an annuity. The greater the contributions are into an annuity, and the longer the length of the accumulation period, the greater your cash flow will be when it is rolled over to the annuitization phase. Essentially, if an investor pays into their annuity during their entire work life their annuity will have a substantial sum accumulated when the annuitization period begins.
  • Annuitization Period- The annuitization period is after the accumulation period and it begins when the annuitant starts to receive payments of interest earned. It can be quite substantial if the investor chose to have their annuity deferred and has paid contributions throughout their work life.
  • Immediate- The annuitization period begins immediately after the investor contributes a large lump sum into an annuity.
  • Deferred- The investor chooses to save and defer their contributions into an annuity. In addition, it refers to the investment gains are tax deferred until the investor withdraws the money.

Fixed Annuities

Fixed annuities are typically considered a safe long term investment. It is an agreement between you and a life insurance company and can be purchased with one single large payment or several partial payments. The agreement implies that the insurance company will pay you a fixed rate of interest for a set period of time, although the rate can change there is also a minimum interest rate that protects your investment. A fixed annuity can be paid out immediately (fixed immediate annuity) or deferred (fixed deferred annuity).

Indexed Annuities

Indexed annuities allows the investor to participate in the market fluctuations by having the interest rate tied to economic performance. An indexed annuity is very similar to a fixed annuity in nature. It's return on investment and risks are best for a medium to long term type of investment.

There are many factors that determine the interest rate of an index annuity and the rate fluctuates day by day. In addition, the return on investment can be either immediate or deferred.

Immediate Annuities

A classification of annuity that describes how the disbursements or distributions are paid out. With this type of investment the distributions start immediately after the contract between the annuitant and the insurance company is created and paid with one lump sum.

Life Annuities

A classification of annuity describing the type of pay out the annuitant receives. This contract of the annuity is paid into with one single large payment, therefore it creates monthly cash flow until the annuitant expires. After expiration any value left in the investment reverts back to the life insurance company.

Deferred Annuities

A classification of annuity that describes how the contract between the annuitant and the life insurance company is created and paid into as well as how the disbursements or distributions are paid out. Deferred annuities have an "accumulation period" and pay out of distributions begins after the accumulation period concludes. The interest earned are also tax deferred.

Investors who wish to save for their retirement usually choose the deferred type of annuity. This allows the investor to pay for the contract in payments rather than one lump sum, thus giving the investor the ability to use their assets for other things.

Variable Annuities

A variable annuity is contract between you and a life insurance company and purchased with a lump sum payment or several partial payments. The annuity is then spread out into different sub-accounts that can include: mutual funds, stocks and bonds, or money market accounts. As the name implies, the rate is variable and dependent upon the performance of the investments that you choose.

Variable annuities are long term investments that can generate monthly cash flow once the payout phase begins, and the payout phase is dependent upon the structure which can be immediate or deferred.