Annuities are insurance contracts that promise to pay you regular income either immediately or in the future. You can buy an annuity with a lump sum or a series of payments. The income you receive from an annuity is taxed at regular income tax rates, not capital gains rates, which are usually lower.
The wide menu of annuity products can seem daunting to investors who are considering whether annuities make sense for their portfolios. Even more confusing is that each type of annuity can also have different options or “riders.”
And every rider has different costs and benefits.
Understanding the different types of annuities and how they work is crucial for investors to make the right decisions for their needs. This holds true whether you have an annuity and are considering selling the payments or are thinking about buying an annuity.
Fixed, variable, and fixed indexed are the main types of annuities. Knowing what level of risk you’re comfortable with will help guide you through your annuity choices.
Interest-rate risk is a factor in determining the calculation of your payments. Low risk yields predictable payment amounts. The higher risk could boost your expectations.
This is the option with the least risk and the most predictability. Fixed annuities come with a guaranteed, set interest rate that doesn’t vary beyond the terms of the contract. While other investments might soar or dive, the fixed annuity is steady. Sometimes, however, the interest rate will reset after a predetermined number of years.
Indexed annuities, also known as equity-indexed annuities and fixed-indexed insurance products, have characteristics of both fixed and variable annuities. It’s a way to balance the risks and rewards, carrying lower risks than variable annuities and higher income potential than fixed annuities. So the interest rate won’t sink below a preset amount. But the rate is also tied to a specified index, such as a stock market index, and can rise higher than a fixed annuity. The trade-off is that this kind of annuity also has higher costs and fees than a fixed annuity has. And the methods for calculating interest are complex.
Registered index-linked annuities provide exposure to a published stock market index along with a level of protection from market loss. While this kind of annuity tracks the movement of an index, it does not directly invest in any stock or equity vehicle. Because you assume some of the risks of loss from market downturns, a registered index-linked annuity may allow for greater growth potential than other fixed or fixed index annuities.
A variable annuity comes with more risks and potentially higher rewards. The interest rate of variable annuities is tied to an investment portfolio. Payments from variable annuities can increase if the portfolio does well, but they can also decrease if the investments lose money.
Converts a lump sum into a guaranteed cash flow that can last for a certain period (usually 10 or 20 years) or for your lifetime. Income annuities are classified as an immediate annuity or deferred income annuity. An immediate annuity begins payments within twelve months of the issue date and any income annuity that begins payments thirteen months or more after issue.
Payout options designate when the annuity owner will begin recieving payments.
An immediate annuity also called an income annuity or single premium immediate annuity (SPIA), is a type of annuity designed to provide guaranteed income payments that must begin between one month and one year after purchase. The purchase of an immediate annuity is usually an irrevocable decision that cannot be undone once the free-look period has expired following the contract issue.
A deferred annuity would better be defined as a category of annuities rather than a type of annuity. All annuities can be categorized as either deferred or immediate. When income payments are scheduled to begin is the determining factor as to which category an annuity belongs. There are many different types of annuities that fall underneath the broader deferred annuity category.
A deferred annuity has two phases: the accumulation phase, where you let your money grow for a period of time, and the payout phase. During accumulation, your money grows tax-deferred until you withdraw it, either as a lump sum or as a series of payments. You decide when to take income from your annuity and therefore, when to pay any taxes owed. Gaining increased control over your taxes is one of the key benefits of deferred annuities.
irrevocable decision that cannot be undone once the free-look period has expired following contract issue.
Typically, income annuities are used to protect against longevity. An annuity can provide guaranteed lifetime income insuring the annuity owner does not outlive their money. Income can be based purely on lifespan but payout options also include lifespan plus a guaranteed component or guaranteed for only a certain period.