Annuities Explained
Annuities are term deposits with insurance companies. They are similar to certificates of deposits at the bank (note: bank deposits are FDIC insured while the issuing insurance company guarantees annuities). There are two types of annuities: fixed and variable.
Fixed Annuities Explained
Fixed annuities have these general features:
• Your principal is guaranteed by the claims-paying ability of the insurance company; it will never decline.
• The insurance company adds interest to your deposit each year.
• The annuity is for a specific term that you select. Generally, the longer the term, the higher the interest.
• All interest is tax deferred (you do not report it on your tax return) until withdrawn.
• You may withdraw 10% of your balance annually.
• If you withdraw more than 10% during the term, you will pay withdrawal penalties (called surrender charges).
Most fixed annuities offer an initial one-year rate and then the rate changes each year. A few companies offer a locked-in rate for the entire period (called multi-year gaurantee annuities).
Another type of annuity is called a variable annuity.
Variable Annuities Explained
With this type of annuity, rather than receiving interest from the insurance company, your money is invested in mutual funds. You may earn more or you could lose principal, depending on the mutual funds you select.
Maybe the best choice is an index annuity.
Index Annuities Explained
In this type of annuity, your principal is guaranteed, like the fixed annuity, but your interest each year is based on increases in the S&P 500 Index. So, your interest is tied to the performance of the stock market but you can never lose your principal. You get the guarantee of a fixed annuity, with the potential profit of a variable annuity.
Everything described up until this point describes the growth phase (called the accumulation phase) of the annuity. To see how much you’ll have at the end of the accumulation pahse, you can use a fixed annuity calculator.
When and how do you get your money out? At the end of the term, you have three options:
You can leave the annuity alone and continue to let it grow.
You can exchange the annuity to another company that may pay you a higher rate.
You can start to make withdrawals.
The withdrawal phase is called the distribution phase. You have three options:
You may withdraw all of your money at once
You can withdraw some money each year based on your desires
You can annuitize the policy.
“Annuitizing” means that you accept fixed monthly payments from the annuity company. The payments can span your lifetime or be limited to a specified period (e.g. 10 years). At the end of the period you select, the annuity is completely paid out. If you select a lifetime payout, the payments will continue for as long as you live.
As you might imagine, the monthly payments are usually more for a fixed 10-year payout than if you select a lifetime payout (the option, which pays the most, depends on your age).
Annuitizing may or may not be a good deal and will depend on your circumstances.
If you are single and need to maximize your monthly income, the lifetime payments may be a very good deal. On the other hand, if you want to leave money to your heirs, annuitizing would not be good because there will be nothing left at the end of the annuitization period.
Immediate Annuities Explained
An immediate annuity has no accumulation phase. It is for supplemental retirement income and almost like receiving a 2nd social security check. You make a deposit with the insurance company and immediately begin receiving payments. These annuities are generally suited for senior investors (age 70 plus) who desire to increase their monthly income.
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Tags: annuities explained, annuity calculator, supplemental retirement income
May 16th, 2009 at 7:55 am
The lifetime annuties sound like a good idea for retirement income. One thing i know is you have to make sure the company you buy one from is a good company and is in good financial shape.
September 5th, 2009 at 10:15 pm
We’ve been using variable annuities for the past few years and have done pretty well (luckily) despite current economic conditions. I suppose we made some good mutual fund decisions, although we’re considering switching to a Fixed now.
October 13th, 2009 at 8:24 pm
I like the idea of variable annuities as opposed to having a fixed annuity
November 17th, 2009 at 2:14 am
I’ve always heard negative things about lifetime annuities, but maybe I was missing something. I didn’t know they were good for retirement. I suppose making sure the seller is reputable is pretty important.
January 11th, 2010 at 12:05 am
I think variable annuities have a great future.
Thanks for the article.
January 23rd, 2010 at 12:34 am
I agree use an annuity calculator to ensure you get a good comparison between the different annuities.
January 31st, 2010 at 11:40 am
The nice thing about a lifetime annuity is that if you live longer (which is hopefully the case for all of us) then you keep getting paid monthly payments even if it extends beyond the amount of principal you paid in to the annuity in the first place. The fees can eat away at the return a little too much for my taste, but I really love the idea of payments for life, especially with the market over the past few years.
February 1st, 2010 at 6:24 am
Annuities Explained. An annuity is a retirement product in which you make one or more contributions to an insurance company.
February 20th, 2010 at 8:26 am
I prefer fixed term annuities as you can get another bite of the cherry at the end of the fixed term. This means at this point you may qualify for enhanced rates.
February 27th, 2010 at 3:31 pm
My mother-n-law is considering a fixed annuity for 130k in the names of her daughters in order to qualify for VA pension assistance of $1065/mo. Is there a better option? A trust?
April 6th, 2010 at 11:28 pm
An annuity calculator is an excellent tool to help find the right options you need within your annuity. For Income Drawdown it is equally important to find the income drawdown calculator.
Kevin
April 15th, 2010 at 9:44 am
Technically, equity indexed annuities are characterized as fixed annuities by the various Departments of Insurance in each state. That is to say, at no point does the investor ever own any variable type of security like a stock, bond or mutual fund within the EIA account. These accounts do not fluctuate in value like a variable annuity might. Yet the equity indexed annuity is not like your typical fixed annuity either
June 28th, 2010 at 3:35 am
The number of people investing in the annuities has increased. This is because annuities are safe investments and it is a flawless retirement investment plan
July 28th, 2010 at 1:01 pm
I have been researching annuities and see if they are a good investment for my future. They seem almost flawless and everyone should give them a chance for a great retirement.
August 9th, 2010 at 6:23 pm
In a recent review of annuities I found both pro’s and con’s for annuities. Costs and fees are the negatives, but from a diversification perspective they do offer a good option in one’s retirement portfolio.
August 12th, 2010 at 6:20 am
What would happen if the company that you have chosen goes out of business or goes bankrupt, do you have some financial security somewhere?