Types of Annuities

Let’s take a closer look at the four main types of annuities.  Keep in mind that there are many variations, riders, and other add-ons that can be looked at above and beyond these basics.  Because of some of the complexities, you should always consult a financial advisor when considering the purchase of an annuity.  Not only will they be able to help you understand the exact details for any one annuity, they will also be able to help you understand the fees, surrender charges, and other fine print that can sometimes makes an annuity a bad investment.

Fixed Annuities

Fixed annuities are products that pay a guaranteed rate of return over a defined period of time, and can be used as a low risk method of supplementing other retirement income.  They can be either immediate, or deferred, with immediate paying defined payments for the length of the annuity, and deferred earning interest over a period of time until payouts begin.

You will hear some people compare fixed annuities to bank CD’s since they both pay a guaranteed rate of return, but be sure to talk with your financial advisor about the specifics since there are many differences.  Specifically they are taxed differently, and while initial rates on annuities are often higher, associated fees can also be higher, eroding the benefit.

Fixed rate annuities can be good conservative investment products, just make sure you are well aware of the details.

Variable Annuities

These are a more risky form of annuity because the value of the product is determined by a set of investments.  Because of this, a variable annuity acts more like a traditional investment in a mutual fund, meaning you can get the benefit of increases in the market.  This also means the investment is risk of decreasing in value, which is why you can also purchase a rider which guarantees a certain minimum income stream.

Variable annuities can also have higher fees associated with them, which can wipe out some of the positive returns you were hoping to get.  At the end of the day, it’s very important that you go into any annuity contract with the advise of a qualified financial or insurance advisor who can help you understand the fine print.  With variable annuities this is especially true.

Immediate Annuities

These annuities begin to payout within 12 months of their purchase.  They are most popular among retirees who are looking to guarantee income for a certain period of time, typically between five and twenty years, or in some cases for the rest of your life.  Immediate annuities can be either fixed or variable, giving you some options in the amount of risk and growth you’d like to get out of the investment.

A typical fear is that the insurance company keeps the funds invested in the annuity after death, and if you pass away long before getting the full benefit of the annuity, it’s a very poor investment.  The reality is that these types of annuities do exist, but there also exist options to guarantee payout of the purchase value which can go back to your family members.  The complexities give you options, but again make it important to seek professional advice.

Deferred Annuities

These are annuities that do not begin payouts until at least 12 months after the purchase.  Deferred annuities are most often purchased by people looking to create a guaranteed future income stream for themselves, but don’t have a need in the short term, as with someone purchasing an immediate annuity.

Some people would equate a deferred annuity to purchasing a pension for yourself and/or spouse, and are typically less expensive because the insurance company gets your principal for a period of time without having to make payments.

Bottom Line

At the end of the day, annuities can be a tool used in your overall retirement portfolio especially in respect to providing an income stream for a set number of years.  It is however important to understand the fine print of any annuity contract you enter into.  Make sure you have a firm understanding of all the fees associated with this type of investment, as well as the specifics of what happens to your principal and future payments after passing away.

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