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Understanding Different Types of Annuities

If you want to make some changes to your portfolio or begin investing your money wisely and are considering annuities, it's important to make sure that you fully understand what they are, the different types available or if you even need one.

Essentials of Annuities

The long and short of it is this: an annuity is basically an insurance policy. You must also understand that it’s not a typical investment. Your contract with the company offering the annuity specifies when you’ll get your money back, how and what interest rate you’ll earn.

In contrast to IRAs, there’s no limit to how much money you can put in your annuity. This is especially helpful for people who are nearing retirement and need to compensate for not putting more away sooner. When you’re ready to withdraw from your annuity (assuming your plan allows it), you can either take a lump sum or arrange to receive payments on a regular basis for your lifetime or for a certain time period.

When you’re considering an annuity for retirement, which insurance company you purchase from matters. You want to choose a company that is fiscally proven and strong so you can be sure it will still be in business when you retire many years after you initially buy the annuity.

Because there are so many different types of annuities, it can get confusing. It's important to review some of the more common annuities and how they work and consider the pros and cons (which largely depend on the type of annuity and what your goals are).

Immediate Annuity

In this agreement, you give the insurance company a chunk of money, and monthly, they pay you a guaranteed amount of money. If this payout is over a specific period of time, like 10 years for example, that’s called a term certain annuity. If they promise to pay you for the rest of your life, that’s an immediate annuity.

This type of annuity is great for an older, single, retired person because no matter how long you live, you will still collect your monthly payout until your death. This can provide a buffer during retirement years in case a person outlives his or her other investments.

The downside to this option is that the money is not readily available to you to withdraw. It’s off limits. You are only allowed to collect the agreed upon amount of money each month, no matter how much is in your policy.

Fixed Annuity

Similar to a bank’s certificate of deposit (CD), a fixed annuity is an insurance policy in which the company guarantees your money’s interest rate (which is tax deferred) for a specified time period (usually 5-10 years). When you withdraw your money, you must pay taxes. You’re subject to income taxes, along with a 10% penalty, if you withdraw interest before age 59.5.

After the allotted time period, you can either keep the annuity (probably at a different interest rate), switch to a different annuity, or withdraw the money to invest somewhere else. The benefit to this option is that it’s not a high risk investment as long as you don’t mind leaving your funds alone for the length of the annuity.

Indexed Annuity

These are sometimes referred to as fixed indexed annuities or equity indexed annuities. With this type of annuity, the company not only promises a minimum payout but also offers additional income that’s based on a formula tying your account to how the stock market is performing.

Indexed annuities can get complicated because of cap rates and participation rates that affect how your income is determined. But if you’re approximately 10 years from retirement, a variation of the indexed annuity called a deferred indexed annuity could be a great option because it guarantees how much money you’ll have during your retirement years.

Variable Annuity

This type of contract offers you more input into how your funds are invested, but it’s one of the most complicated as well. The income you receive varies depending on which investment subaccounts you choose. Since the interest rate isn’t guaranteed, the guarantee you receive is in the form of a death benefit.

Similar to an IRA, your investment is tax deferred. This is convenient if you’re interested in moving your investments from your annuity to your IRA (or vice versa) because you don’t have to worry about capital gains taxes.

All in all, this isn’t the best annuity compared to others unless you’re looking for another tax-deferred option besides your maxed out 401(k) plan and IRA.

Deferred Annuity

This is exactly what it sounds like. After you purchase a deferred annuity, you begin collecting your payouts at a later date (usually 10 or more years down the road). With this arrangement, you don’t have to worry about a stock market slump impacting your retirement plans because it’s guaranteed.

This is also known as longevity insurance. A qualified longevity annuity contract (QLAC) is a special kind of deferred annuity you can buy using money from your 401(k) or IRA. You begin receiving payouts at age 85 with the QLAC option, which means you can count on a certain amount of money in your later years.

It should also be noted that you can often choose a deferred option with other types of annuities (like fixed, indexed and variable) where you can purchase a specific amount of guaranteed income for the future. If you’re interested in this, ask your financial advisor about a guaranteed withdrawal benefit, living benefit or guaranteed income rider.

Is an Annuity Right for You?

Because there are so many different kinds of annuities, which one you buy could be either good or bad for you depending on why you’re buying it and how you’ll use it. If you’re not sure whether an annuity would be in your best interest, it’s recommended that you seek professional financial advice from someone you can trust. They can determine if an annuity would be a smart move or not and suggest which one would be best for you as well.

Insurance products are not a deposit or other obligation of or guaranteed by any bank or bank affiliate. They are not insured by the Federal Deposit Insurance Corporation (FDIC), any other federal government agency or any bank or bank affiliate. Annuities are for long-term investing and may be subject to investment risk, including possible loss of value.

Recent articles by Walter Russell: Comparing Term and Whole Life Insurance

 

Disclosure: This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.