What is an Annuity?
An annuity is a financial contract issued by an insurance company. It provides a way to accumulate funds for the future that are systematically distributed over a given period. The annuity policy owner deposits money into the contract in the form of a premium. The insurer then invests the premium which is credited with a certain rate of interest earnings or grows in value in relation to the investments’ performance. At a future date, designated by the policy owner, the insurer converts all or a portion of the contract’s funds into a series of periodic income payments to the policy owner. These payments are actuarially calculated to extend for a certain number of years or for the policy owner’s lifetime. The process of converting the funds into payments is known as annuitization.
By design, annuities can serve as both asset accumulation vehicles and asset distribution vehicles. This makes them well suited for retirement planning. Your personal goals and risk tolerance will help determine what type of annuity is best for you.
Types of Annuities
Immediate Annuity – This type of annuity serves exclusively as an income distribution vehicle. Its purpose is to generate an ongoing, systematic stream of income. A short time after the contract begins – typically within one month – the deposited premium is annuitized into guaranteed, periodic income payments. Often called a SPIA (i.e., Single-Premium Immediate Annuity), an immediate annuity requires the deposit of a single lump-sum premium at contract initiation.
Deferred Annuity – A deferred annuity is designed to accumulate funds for the long term. It may be funded with a single lump-sum premium or a series of premium deposits. Deposited funds are credited with a certain rate of interest earnings or grow in value during an accumulation phase (typically 8 – 10 plus years). At the end of the accumulation phase, the policy owner may withdraw all or part of the funds; let the funds in the contract continue to accumulate; or convert the funds into a series of periodic income payments. Policy owners may incur fees if they withdraw funds from a deferred annuity during the accumulation phase.
Deferred Income Annuity – While similar to an immediate annuity, deferred income annuity (aka DIA) payments do not begin immediately. The time to begin payments to the policy owner is deferred to at last 13 months. Typically, the deferral period is 5, 8, or 10 years.
Multi-Year Guaranteed Annuity – Commonly known as a MYGA, this annuity has a pre-determined interest rate that’s guaranteed by the insurer for the entire term of the contract. A MYGA offers flexibility and liquidity by allowing the policy owner to take partial withdrawals annually without a penalty.
Fixed Annuity – A fixed annuity is conservative investment vehicle, appropriate for policy owners who don’t want to risk their premium; want conversative returns; and are fine with minimum guarantees. Fixed interest levels are declared by the insurer in the contract. At annuitization, the policy owner receives fixed, unchanging payments. This deferred annuity typically requires a holding period of 2 – 15 years, depending on the insurer, before the policy owner can receive payments without paying additional fees.
Indexed Annuity – An indexed annuity, also known as a Fixed Indexed Annuity (i.e., FIA), allows a policy owner to earn interest based on the performance of a tracked market index without the risk of actually investing their premium in the market. The policy owner designates which markets to track and can change their choices at timeframes set by the insurer. Interest credited in an indexed annuity is based on whether the tracked market index increases or decreases. If a tracked market index (such as the S&P
500) increases, that increase will be the base for calculating the interest earned. If the tracked market drops or decreases, the floor interest amount is received. The floor amount is never less than 0%, so the policy owner’s premium will never decrease. Therefore, the policy owner participates in some of the tracked market’s gains, but none of its losses. This type of deferred annuity is sometimes called an Equity Indexed Annuity.
Variable Annuity (i.e., VA) – In this deferred annuity, the policy owners’ premium is invested into non- guaranteed investment portfolios maintained by the insurer. These portfolios are similar to mutual funds and may consist of stocks, bonds, and money market accounts. The performance of a variable annuity’s underlying investments determines the growth of the annuity. If the underlying investments perform well, the annuity’s value increases. If the underlying investments perform poorly, the annuity’s value may decrease. There are generally no guarantees associated with the value or growth of a variable annuity.
Current Annuity Interest Rates
If you’re curious about interest rates for the different annuity types, you may scroll through them by clicking below:
We’d love to learn about your vision for your retirement and help you make an informed decision about the best annuity type for you. Contact us to learn more.
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