Types of Annuities
Because there are several different types of annuities, there may be one that fits into your financial plan better than another, depending on your time horizon and your overall financial goals. One way to categorize these products is in how quickly they pay out an income stream. In this case, there are immediate and deferred annuities.
Immediate versus Deferred Annuities
An immediate annuity will typically be funded with one lump sum contribution, such as the money from an IRA (Individual Retirement Account) and/or employer-sponsored retirement account like a 401(k).
The immediate annuity will then begin to pay out an income stream right away, or very soon after the contribution has been made. (Often, the payout will start within six months of purchasing an immediate annuity). With that in mind, immediate annuities are usually purchased by those who are already retired or soon will be, and who are in need of an income stream.
Conversely, a deferred annuity can be funded over a longer period of time. With this type of annuity, regular contributions may be made, or money can be added sporadically over time. The funds that are inside of a deferred annuity are allowed to grow on a tax-deferred basis. This means that there is no tax on the gain until the time of withdrawal.
Fixed versus Variable Annuities
Another distinguishing feature of an annuity is whether it is fixed or variable. Although both types of annuities may be funded in a similar fashion - and offer like payout options - there is a difference in how these products operate.
A fixed annuity typically offers its holder a fixed amount of interest that is credited on an annual basis. The interest rate with a fixed annuity is declared by the insurance company that offers the annuity.
One of the primary benefits of a fixed annuity is its safety of principal. This can allow the owner of a fixed annuity peace of mind in knowing that they will not lose principal - regardless of what happens in the market. In return for this safety of principal, though, the return on fixed annuities is typically somewhat low.
Variable annuities are set up in a similar fashion to fixed annuities. However, these products allow their holders to participate in stock market appreciation with their funds through a number of different investment options, such as mutual funds. The owner of a variable annuity will not be investing directly in the market, though. Rather, the funds are held in the insurance company's "sub-accounts."
Those who own a variable annuity have the potential to grow their account a great deal, provided that the underlying investments perform well. However, these types of annuities may also be considered riskier than fixed annuities due to the potential of poor market returns.
Another type of annuity is a fixed indexed annuity. These annuities have their return based in large part on the performance of an underlying market index, such as the S&P 500. Here, if the underlying index performs well during a given year, the annuity will be credited with a positive return, usually up to a set maximum, or "cap."
If, however, the underlying market index performs poorly, the annuity holder will not suffer loss in their account. Rather, the return is just simply credited with a 0% for that time period. So, while there is not any gain in the account for that year, there is also no loss incurred.
Single Premium versus Flexible Premium Annuities
Annuities can also be sorted by how and when the premiums are paid. For example, there are single premium annuities and flexible premium annuities. With a single premium annuity, as the name implies, the annuity is purchased with one single lump sum premium.
In this case, the annuity owner can purchase a single premium immediate annuity (SPIA), where the income stream starts right away, or they may conversely purchase a single premium deferred annuity (SPDA) where they deposit a lump sum, let their funds grow over time, and defer their payments until later on in the future.
A flexible premium annuity is an annuity purchased with a series of contributions over a period of time. In this case, the annuity owner is typically allowed to change the amount and/or the frequency of contributions.
Which is the Right Annuity for You?
With the many different annuity options that are available today, it can be difficult to determine which type is right for you. So, before committing to a particular annuity product, it is important to discuss the various alternatives with an expert in the annuity marketplace.
That way, you can be more assured that your questions will be answered, and that you have the right annuity that is in line with your risk tolerance, time horizon, and overall financial and retirement goals.