Annuities & How They Work
What Is an Annuity? An annuity is an insurance contract sold by insurance companies to provide a guaranteed income in exchange for a payment or series of payments. Generally, the beneficiary pays an insurance company a premium, and in return, the insurer provides income payments at regular intervals for the rest of your life (or some other period).
Annuities are most often bought for retirement income, and can pay an income that lasts as long as you live. Below are different classifications of Annuities, each based on the provisions of the contract.
Types of Annuities
There are several types of annuities, all of which carry varying levels of risk and guarantees. To get the most out of an annuity, it’s important to know the different options available to you, as well as the benefits each type provides.
Single Premium Annuity – You make a single premium payment to the insurance company.
Multiple Premium Annuity – You make multiple premium payments to the insurance company.
Immediate Annuity – You begin receiving income payments no later than one year after you pay the premium.
Deferred Annuity – You begin receiving income payments many years later.
Fixed Annuity – In a fixed annuity contract the beneficiary receives a fixed income stream for the term of the contract. Your money, less any applicable charges, earns interest at rates set by the insurance company or in a way the annuity contract specifies.
Variable Annuity – In a variable annuity contract, the value of the contract varies based on the performance of an underlying portfolio of securities or mutual funds. The insurance company invests your money, less any applicable charges, into a separate account based upon the level of risk you want to take. The money can be invested in stocks, bonds, or other investments. If the fund does not perform well, you may lose some or all of your investment.
Equity-Indexed Annuity – An indexed annuity is a variation of a fixed annuity in which, the value of the contract varies based on the performance of a specified market index, such as the S&P 500. The annuity pays a base return, but it may be higher if the index increases.
Finding the Right Annuity for You
To decide which type of annuity to purchase, think about your financial goals for the future, specifically around retirement. Analyze the amount of money you are willing to invest in an annuity, and how much of a monetary risk you’re willing to take. When determining whether an annuity would benefit you, ask yourself these questions:
How much retirement income will I need in addition to what I’ll receive from Social Security and my pension plan?
Will I need additional income for family members or loved ones?
How long do I plan on leaving money in the annuity?
When do I plan on needing income payments?
Will the annuity allow me to gain access to the money when I need it?
How much risk am I comfortable with?
Do I want a fixed annuity with a guaranteed interest rate and little or no risk of losing the principal?
Do I want a variable annuity with the potential for higher earnings that aren’t guaranteed and the possible risk of losing the principal?
Am I somewhere in between and willing to take some risks with an equity-indexed annuity?
