The wide variety of annuities offered by insurance companies can make this investment product confusing and intimidating. However, most annuities fall into a few categories. Therefore, you can simplify the process of choosing an annuity by first understanding the types of annuities.
Immediate or deferred payments
The first category of annuities is based on when annuity payments begin: immediate or deferred. With an immediate annuity, payments begin when you purchase the annuity, while, with a deferred annuity, payments begin on a set date sometime in the future.
Fixed, indexed or variable annuities
The second category of annuities is defined by how the annuity funds are invested and how payments are determined. This category includes three types of annuities: fixed, indexed and variable.
A fixed annuity pays a set amount to the annuity owner on a regular basis. This amount may be paid for a predetermined period (such as 20 years) or for the annuity owner’s lifetime.
A variable annuity allows the purchaser to invest the annuity funds in mutual funds or other investment options. The annuity payments are determined by the performance of these investments and they may vary over time as performance changes.
The return on an indexed annuity is based in part on changes in an index, such as the S&P; 500. In addition, a minimum interest rate usually is guaranteed. As a result, indexed annuity payments generally include a fixed payment based on the guaranteed interest rate plus a variable payment based on the performance of the applicable equity index. Thus, an indexed annuity is a hybrid with some characteristics of fixed annuities and some characteristics of variable annuities.
Payments for all of these types of annuities (immediate or deferred and fixed, indexed or variable) may continue for a set period of time (such as 10 or 20 years) or for the lifetime of the purchaser or purchasers, depending on the annuity’s terms.
How to choose
These descriptions are relatively simple. While most annuities fall into these broad categories, their terms can vary widely. Nevertheless, when choosing an annuity, one good place to start is by asking yourself the following questions. The answers can help you narrow down your choice and make the final decision a little easier.
What is my goal in purchasing an annuity? Is it to generate a stream of income for the rest of my life or to invest funds and generate a return for a set period of time? Also, do I need annuity payments to begin immediately or at a date in the future (perhaps when I retire)? The answers to these questions can help you choose between an immediate and a deferred annuity and between lifetime payments or payments that will continue for a set period of time.
How important are guaranteed annuity payments? How comfortable am I with investment risk and payments that may vary over time? The answers to these questions will determine whether a fixed annuity is your best choice, whether the risk (and perhaps higher returns) of a variable annuity are right for you, or whether a hybrid indexed annuity meets your needs.
Do I want a straightforward, plain vanilla product? How confident am I when evaluating complex financial products? Annuities come in all shapes and sizes with plenty of variation in how returns and payments are calculated and other factors. By evaluating your ability to understand these crucial details, you can decide whether a simpler, more basic annuity is your best bet or whether you a more complicated product, perhaps with the possibility of higher returns, will better match your needs.
Sources:
Types of Annuities – Immediate, Variable and Fixed Annuities
Annuities
FINRA – Investor Alert – Equity Indexed Annuities – A Complex Choice
