Understanding the Different Types of Annuities
Not all annuities are created equal. In fact, there are a myriad of annuity products and options on the market. Each has its own particular strengths and is designed to work well for particular individuals at specific times in their lives.
What is an Annuity?
In short, an annuity is a financial contract between you and an insurance company. You deposit at least one premium into an annuity contract and, unless it is an immediate annuity, those funds will grow on a tax-deferred basis.
Immediate vs. Deferred Annuities
The income benefit offered by an annuity can be either immediate or deferred. In other words, you start receiving payments now, or you pick a point in the future to begin receiving payments.
Immediate Annuities are designed to provide a guaranteed income stream for the duration of one or two people's lifetimes. The income stream is determined by the amount paid to the insurance company, the age or life expectancy of the annuitant(s) who receives the income, and prevailing interest rates.
Deferred Annuities are not intended to produce an immediate income stream. They are designed with either income or withdrawal options. Deferred annuities allow the premium to grow on a tax-deferred basis until funds are withdrawn.
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Some deferred annuities automatically start an income stream at a pre-determined date and others do not require you to withdraw income at all. From the latter, you can withdraw income only as needed, usually from the interest earned, or you may take a lump sum at the end of the interest rate guarantee period when surrender charges have disappeared.
Within the fixed deferred annuity category, there are several types:
Deferred Income Annuities, also known as longevity annuities, are very much like immediate annuities, but with an income start date delayed from 3 to 40 years in the future. They are kind of like a personal defined benefit pension.
Deferred Multiyear Annuities pay a fixed rate of interest each year on the premium. This is similar to a bank Certificate of Deposit, but not backed by the FDIC. Surrender fees on deferred multiyear annuities are usually higher than on bank CDs. You may also hear these referred to as “fixed interest” annuities.
Fixed Indexed Annuities, or “hybrid” annuities, offer a guaranteed interest rate and the opportunity to capitalize on upward market movements by associating the rate of return to an index, such as the DJIA or S&P 500.
How Safe are Annuities?
The security of your premium and the promise to receive the stated interest or income depend entirely on the financial strength of the underlying insurance company. In addition, the guaranty associations of various states offer additional levels of financial protection. However, I always caution potential annuity buyers to look first to the strength of the insurance company and not rely solely on state guarantees.
Who is the Ideal Buyer of an Annuity?
Due to the wide variety of annuity contracts available on the marketplace today, there is an option to fit virtually any individual’s financial needs. The primary reason investors seek annuity contracts as part of their portfolios is for their guarantees. Guaranteed interest rates, guaranteed income streams, and protection of capital are principle drivers for placing premium into an annuity contract.
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Guaranteed interest rates offer assurance that capital will continue to grow as you prepare for or enter retirement. While these interest rates may not initially be as appealing as broader market gain potential, they do provide security.
Guaranteed lifetime income streams offer current and future retirees assurances that you will not outlive their capital, a primary concern amongst aging adults. Essentially, annuities can offer investors a form of “insurance” against many of life’s “what-if” scenarios.
How to Choose the Best Annuity for your Given Needs
With so many annuity products available on today’s marketplace, choosing the right one for your financial needs and goals may initially seem overwhelming.
First, consider the type of annuity that best fits your needs: immediate or deferred. Once you narrow down the type of contract that best suits your financial situation, consider the added riders and options available. Do you need a death benefit? Is inflation protection important to you?
To help guide you through this process, be sure to consult with a trusted advisor who will listen to your needs and concerns and provide clear answers and product options for your consideration. With this information, you can get the best contract to add to your investment portfolio.
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