An Overview of Annuities
An annuity is a contract between you and an insurance company, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date. Annuities typically offer tax-deferred earning and may include a death benefit that will pay your beneficiary a guaranteed* minimum amount, such as your total purchase payments.
Unlike retirement plans, there is no limit to how much money you can put into an annuity! The number of annuity products on the market today can make selecting the most suitable annuity a confusing process. In fact, there are essentially three types of annuities.
- Timing of payout – immediate or deferred: In an immediate annuity, the the annuitant begins receiving payments immediately after purchase. This is for individuals who need immediate income from their annuity. In a deferred annuity, payments begin at some future date, usually at retirement.
- Investments by Insurers – fixed or variable: Insurance companies invest annuity assets in government securities and high-grade corporate bonds. They offer a guaranteed* rate, typically over a period of one to ten years. Variable annuities provide you more control over where your premium goes, such as securities portfolios, fixed interest accounts, and money market securities.
- Liquidity options – An annuity may allow you to withdraw either your interest earnings or up to 15% per year without a penalty (although any withdrawal from an annuity may be subject to taxes and a 10% federal penalty if taken before age 59 1/2).
Types of annuities
- Fixed annuity: The insurance company guarantees that you will earn a minimum rate of interest during the accumulation phase of the annuity. Plus, it guarantees that the periodic payments will be a set amount. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.
- Variable annuity: Provides purchaser more choice where their premium goes through a selection of subaccounts, similar to mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you will eventually receive, vary depending on the performance of the subaccounts you selected.
- Equity-indexed annuity is a "hybrid" type of annuity. During the accumulation period – when you make either a lump sum payment or a series of payments – the insurance company credits you with a return that is based on changes in an equity index, such as the S&P 500 Composite Stock Price Index. (An annuity’s index account does not credit the same return or a percentage of the return of any index. Dow Jones indices do not include the dividend income of the company stocks that comprise it.) The insurance company typically guarantees a minimum return. After the accumulation period, the insurance company will make periodic payments to you under the terms of your contract, unless you choose to receive a lump sum.
Variable annuities are securities regulated by the SEC. Fixed annuities are not securities and are not regulated by the SEC. Equity-indexed annuities combine features of traditional insurance products (guaranteed minimum return) and traditional securities (opportunity for earnings potential of interest, based on the performance of an index). Depending on the mix of features, an equity-indexed annuity may or may not be a security. The typical equity-indexed annuity is not registered with the SEC.
Anyone thinking about purchasing an annuity should carefully consider the following:
- The rating of the insurance company (indicating their financial strength) issuing the annuity, particularly in the case of a fixed annuity.
- Understand the fees paid to the brokers that market the annuities on behalf of the insurance company.
- Any withdrawal from an annuity may be subject to taxes and a 10% federal penalty if taken prior to 59 1/2 years of age
* Annuity guarantees rely on the financial stability and claims paying ability of the issuing insurance company.