What is an Annuity?
An annuity is an insurance product that can provide you with a stream of payments for a set period of time, typically after you retire. The payments are made either for a specific number of years or for the rest of your life.
Annuity Information
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Annuities are not an investment, but an insurance savings product. You purchase an annuity in exchange for periodic distributions later, essentially guaranteeing retirement income. The amount of income you’ll receive in retirement depends on several factors, including:
- The size of your principal (how much you pay into the account).
- Interest rates/potential growth during any applicable accumulation period.
- The age you start taking distributions.
- Your life expectancy.
Annuities can technically be purchased at any age, but most insurance companies require consumers to be over the age of 18, and under the age of 90.
Types of Annuities
Deferred
Deferred annuities are contracts for people who want to save on a tax-deferred basis for many years, and then convert to a payout schedule once they retire. Contrary to an immediate annuity, taxes are deferred and do not become payable until some years after its purchase.
The single premium or regular premiums are capitalized during the deferred period. Then the built up capital is converted into an annuity. Deferred annuities typically stipulate that payments be made to the annuitant at a later date, such as when they reache a certain age.
Equity Indexed
An annuity whose returns are based upon the performance of an equity market index, such as the S&P 500, DJIA, or NASDAQ. The principal investment is protected from losses in the equity market, while gains add to the returns.
Fixed (Fixed Rate)
Fixed annuities are an investment vehicle offered by insurance companies that guarantee a stream of fixed payments over the life of the conrtract. The insurer, not the insured, takes the investment risk. Fixed annuities are sometimes referred to as fixed dollar.
Fixed Deferred
With fixed annuities, an insurance company offers a guaranteed interest rate plus safety of your principal and earnings.
Your interest rate will be reset periodically, based on economic and other factors, but is guaranteed to never fall below a certain rate.
Flexible Premium
A flexible premium annuity has a regular, periodic payment that varies.
Immediate (Single Premium Immediate Annuity SPIA)
An immediate annuity is purchased with a single payment and which begins to pay out right away. When you purchase a SPIA, it is generally with a single lump sum. Income payments begin within 12 months of the date of purchase.
With fixed immediate annuities, your payment is based on a fixed interest rate. With variable immediate annuities, your payment is based on the value of the underlying investment, usually a stock portfolio.
After choosing a SPIA the owner determines the schedule of payments. The owner can choose payouts to be made either monthly, quarterly, semiannually or annually. Another important decision to make is how long the payments will last. The owner can choose to receive payments for a specified period of time, an entire lifetime, or even for the life of a beneficiary.
Indexed (EIA or FIA)
An Indexed Annuity is based on a statistical indicator, the equity market index, which provides a representation of the value of the underlying securities. An EIA is a hybrid of both fixed and variable.
Indices often serve as guides for a given market or industry and benchmarks against which financial or economic performance is measured. They can be based on the S&P, Nasdaq, DJIA and others.
The principal investment into the FIA is protected from losses in the equity market, while gains add to the annuity’s returns. This means that once you make a premium payment you will never have less in your indexed account than your premium payment, and as the index appreciates in value, so does the Indexed annuity. They can be a wise investment and become a great source of additional income revenue.
Life Annuity
A life annuity continues to pay out as long as the annuitant is alive.
Nonqualified Deferred Annuity
A contract that provides for tax deferral of investment income until withdrawn from the contract. Fixed annuities offer a fixed rate of return for a stipulated period, while variable annuities offer a choice of investment options.
Nonqualified Income
A contract that provides periodic payments based on life or joint life expectancies and/or a period certain (i.e., life and 10 years certain). The periodic payment amount is based on the amount used to purchase the contract, the terms of the payout, and an assumed rate of return.
Nonqualified Sources
Funding can come from many sources. Non-qualified sources are where the money has already been taxed, such as cash, mutual funds, certificates of deposit (CDs), and money market funds.
Qualified
Qualified annuities are purchased for funding an IRA, 403(b) tax-deferred, or other type of retirement arrangements. An IRA or qualified retirement plan provides the tax deferral.
These contracts should be used to fund an IRA or qualified retirement plan to benefit from the features other than tax deferral, including the lifetime income payout option, the death benefit protection and, for variable annuities, the ability to transfer among investment options without sales or withdrawal charges.
Qualified Retirement Plan
Qualified retirement plans are generally any plan or arrangement eligible for special federal income tax treatment. Examples of qualified retirement plans include 401(k) plans, profit sharing plans, IRAs, etc.
Glossary
Annuitant
The person, usually the owner, whose life expectancy is used to calculate the income payment amount.
Annuitization (Annuitize)
When you annuitize your contract, you trade the value of your annuity for the issuing company’s guarantee to make payments to you periodically for a certain time, or for the span of your lifetime.
Contract Agreement
An annuity is a contract issued by a life insurance company that provides for tax deferral of investment income until withdrawn from the contract. This can also be referred to as a contract or agreement by where you receive fixed payments on an investment for a lifetime or for a specified number of years.
Owner
The annuity owner is the person or people who make decisions about the contract’s investments. The owner or owners have the right to make withdrawals, surrender or change the designated beneficiary or other terms of the contract.
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Information courtesy of Barry Page and Annuity.com
Note: All guarantees are subject to the claims-paying ability of the insurer.