Types of Annuities
There are many options when looking at annuities to fit your goals. With an annuity, you may be able to choose from a range of benefit options, which may have an additional cost, to help customize your annuity to best suit your goals and needs. Benefit options can address things like how and when you take income, whether your spouse or loved ones are covered as well, how much income you get, and what it costs.
The costs of annuities will vary based on the benefits you choose. Annuities meet many different needs and often can be customized with benefits for an additional cost. Like buying a car or house, you select the features that are most important and valuable to you.
There are three main types of annuities:
- Fixed Annuities
- Variable Annuities
- Fixed Indexed Annuities (Often called Indexed Annuities)
Immediate and deferred (or “at a later date”) classifications indicate when you will begin receiving your annuity payments. It’s important to consider your income goals, risk tolerance and payout options when deciding which type of annuity is right for you. Different types of annuities have varying levels of risk, upside potential and payout options. Your personal goals and objectives will help determine the best annuity for you. It’s important to work with a financial professional that has expert knowledge on the many options available in the in the annuity market.
Why So Many Types of Annuities?
One of the reasons there are so many options available on annuities is that they are contracts between an annuity holder, or the annuitant, and an insurance company. Contracts have different provisions, different costs, different payouts, etc. The upside is an annuity can be personalized to fit your needs. The downside is the vast array of options can seem overwhelming to potential annuitants.
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 which are usually described in additions to the contract called “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. This is part of why it is so important to work with a financial professional that has expert knowledge on the annuity market to help you find the options that meet your objectives.
Preset & guaranteed
Less but known
Tied to an investment portfolio you can pick
Potentially higher but could also have losses
Preset minimum. Can change according to index you can pick like the S&P500
Potentially higher with no risk of loss
This is the option with the least risk and the most predictability. Fixed annuities come with a guaranteed, set interest rate you will receive that doesn’t change during the term of the contract. While other investments might rise or fall with market fluctuations, fixed annuities are not affected by changes in the market. While the very low risk nature of fixed annuities can be attractive, its important to remember they also have no additional upside potential other than the interest you contracted to receive. Typically the interest changes after the selected period or number of years you choose.
A variable annuity comes with more risks and potentially higher rewards. The interest rate of variable annuities is tied to an investment portfolio. You can usually pick what investment options your capital is invested in. Payments from variable annuities can increase if the portfolio does well, but they can also decrease if the investments lose money. Of the annuity options, the Variable will have the highest fee structure. When purchasing a variable annuity, it is important to remember that your financial professional must be a registered investment advisor in order to provide you with advice on these investment products.
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. The interest rate you receive cannot fall below an agreed upon minimum rate, and it can rise as the index it’s tied to rises up to a maximum ceiling.
For example, if our annuity is tied to the S&P500 index and the index falls to a loss during the period, your interest rate can’t fall below your minimum rate and you wouldn’t lose money, but if the index rises by 15% and your ceiling rate is 10%, your returns would be capped at the 10% rate. An additional tradeoff is that this kind of annuity may have fees, depending on the options you choose, compared to a fixed annuity. And the methods for calculating interest can be complex and you should consult a knowledgeable financial professional to make sure you fully understand all the options, fees and costs of indexed annuities which can be a great tool in your retirement planning.
With a deferred annuity, the investor receives payments that start in the future. Typically, this happens when the investor retires. In the meantime, the investment grows on a tax-deferred basis.
How Long Annuities Are Paid
Generally, annuities protect against longevity risk. Annuities can provide guaranteed lifetime income, so the contract owner won’t outlive his or her retirement savings.
These are annuities that guarantee an income stream for the annuity holder’s lifetime. In some cases, lifetime annuities allow for a beneficiary to receive payments after the annuitant’s death. With these annuities, the amount of the payment will be set based on the age of the annuity owner or beneficiary. The longer the person is expected to live, the lower the individual or joint payments are likely to be. This is because the payments are likely to continue longer for younger.
An example of a fixed-period annuity, also known as a term-certain annuity, where the annuity owner can elect to receive their payments over a fixed period, typically 20 or 30 years. With these annuities, the age and health of the annuity holder do not affect the amount of the payments.
Other Annuity Choices
There are numerous ways to design annuity contracts to include provisions for the owner and of the annuity and their beneficiaries. For example, there are qualified and nonqualified annuities. This refers to whether the annuities are held in qualified retirement accounts and covered by the same laws regarding taxation and withdrawal requirements.
Other options include:
- Life-only annuities pay the length of the annuitant’s life and no longer. However, you can choose provisions that provide for your spouse or even a refund.
- Life annuities with period certain pay a certain number of years even if the annuitant dies before the end of the period.
- Joint and survivor annuities provide payments over the lifetime of both the annuitant and a beneficiary.