What are the different types of Annuities?
The five main categories of annuities are:
- Fixed Annuities
- Variable Annuities
- Fixed-Indexed Annuities
- Immediate Annuities
- Deferred Annuities
Depending on your situation every annuity type has advantages and disadvantages. Finding the annuity that works best for your situation will depend on variables including: risk tolerance, preferred payout start date, desired cash flow and your overall investment portfolio goals.
Fixed Annuities – a.k.a. Multi-Year Rate Guaranteed (MYGA)
What are fixed annuities? Fixed Annuities (MYGAs) have a defined percentage yield written into the contract and are guaranteed for a specified period of time. Compared to Certificate of Deposits, Fixed Annuities offer great rates for fixed term investments. A difference worth noting between the asset classes is that with CDs, you pay the taxes annually on the interest earned. In contrast, with Fixed Rate Annuities, you defer taxes on the interest earned until money is dispersed. That means that the interest rate compounds while it is tax deferred, which can be viewed as an added benefit for many investors.
What are variable annuities? Variable annuities provide the savvy investor with a means to invest in annuities that ties the returns to a basket of other subaccounts, like mutual funds. The earnings of the annuity is based on how well the subaccounts perform. Additionally, a rider can be attached to guarantee a minimum income stream independent of how well the market performs. This could prove important to hedge against underperforming subaccounts. Historically this has been an attractive investment for those planning on retirement and want potential for capital appreciation while securing a guaranteed minimum lifetime income.
Equity Indexed Annuities – a.k.a Fixed-Indexed Annuity
What are equity index annuities? This annuity is popular with retirees who want to have a broader market participation in their annuity without downside risk. The basic formula is to take a fixed annuity and add a variable rate to it. The variable rate is usually tied to a market index like the S&P or the Dow Jones. While there is upside potential and participation in growing market indices the value is not 1 for 1. The upside gains are limited by participation rates, caps and spreads.
What are immediate annuities? In an immediate annuity you begin to receive payments immediately following purchase. The insurance company will begin payments within one year and continue for years to come. Disbursements are higher than other forms of annuities because with every payment a portion of the principal is included with interest. Compared to a life insurance plan where you pay into it every month and receive a lump sum upon death, with immediate annuities you pay into it at the beginning for guaranteed income for years to come. This is a popular annuity for someone looking to spend down their capital and still have it gaining an interest rate above a savings account rate.
Read more about Immediate Annuities
What is a deferred annuity? A deferred annuity is a common annuity in which disbursements begin at a specified date in the future, usually more than one year, and will continue on set dates in the future. They offer a guaranteed return on your investment, while providing a secure stream of cash flow in the future. This is a preferred annuity for someone who wants to guarantee an income in the future when it will be needed.
Read more about Deferred annuities.
Among the various specific types of annuities, they all share a common basic idea. Annuities are all basically a contract with an insurance company and an annuitant for a guaranteed income stream.
Annuities are meant to be part of a broader investment portfolio. Typically, annuities will offer attractive returns for lower risk, in return for lower liquidity. Depending on your age and investment goals you might want to have up to 50% of your investment portfolio allocated in annuities.
For retirees who do not want to worry about the ups and downs of the stock market an annuity might be a good choice. The annuity contract defines specific payouts and returns that can be independent of stock market performance.
Corporations who are seeking to manage long term cash flow could also turn to annuities. Since annuities traditionally offer higher rates of return than Certificate of Deposits, savings accounts and even bonds, many corporations prefer annuities for long term investing.
Altogether, there are hundreds of various types of annuities. Variations based on additional riders, terms and payment features means that finding an annuity that is good for your investment goals is quite possible. The important thing is that you, as a buyer, are aware of the various types of annuities so you can make the right decision about which type of annuity best suits your individual needs and goals.