It’s often used as a blanket term, but the meaning of “annuity” can vary widely. Annuities are best clarified according to the following factors: premium payments, payout timing, and interest options. Since all of these factors play into choosing the right types of annuities, consumers should have a solid understanding of how they affect their financial future.
A single-premium annuity is simple in that you make only one payment upon creation of the contract. Most types of annuities (immediate, fixed, indexed, and variable) will offer the opportunity to pay in one lump sum.
As the name implies, a flexible premium allows you to make premium payments over time, instead of dropping a lump sum all at once. This option is ideal for a younger candidate, or anyone expecting regular income over the next several years. The frequency of your premium payments will depend on what the issuing company allows. Some only offer annual contributions, while others can accommodate monthly premiums. You may also be able to set your own limits on the future premium payments you can make.
Also called income annuities, immediate annuities begin the payment process soon after the policy is bought. Typically, payments will start in 30 days. You can choose to receive payments for life or cap them at a certain period of time, like 15 years. Keep in mind that the payment amount will depend on how long and how frequently you wish to receive income payments. Payment amounts for life are also affected by your age and gender.
These types of annuities don't begin the payment process right away; it is deferred, so the owner can continue to pay premium, build up interest, and/or keep the money tax-deferred until it’s needed. This is called the accumulation phase of the annuity. Once you decide it is time to turn on the income stream you can receive your funds in the form of a lump sum or regular income payments. If you prefer the latter, your deferred annuity will undergo a process called annuitization to convert it into an immediate annuity.
Fixed annuities come with protection of principal from market downturns. You’re also guaranteed interest during the accumulation phase, the amount of which will depend on the interest rate you were quoted. Naturally, these types of annuities are appealing for their protection of principal from market loss due to downturns and the guaranteed interest rates. Fixed annuities can be attractive to those with a low tolerance for risk.
Fixed Indexed Annuities
Fixed indexed annuities are an evolution of the traditional fixed annuity. They operate under the same principles as fixed annuities, so they also have the protection of a minimum interest rate guarantee. The difference is that interest crediting is linked to a market index, without participating in the market, which provides the potential for higher excess interest rates over the long term. However, the principal in your annuity contract is protected from market loss due to downturns.
These have the potential for higher returns but also are higher risk because no minimum amount of interest is guaranteed and the owner of the annuity assumes the risk of the underlining investment in the contract. With a fixed annuity, the risk is assumed by the insurance company.