05 Nov Types of Annuities Explained
Many consumers are confused about the types of annuities available.
Perhaps this is because annuities are a very polarizing financial product – people either love them or hate them.
Keep reading for the 5 most common types of annuities so you may make the best financial decision for your future.
What Is an Annuity?
An annuity is a contract between you and an insurance company.
You invest your money with an insurance company, and the institution will either issue a stream of payments for a specified period of time in the future or pay you income on a monthly basis, quarterly basis, or annual basis.
Annuities are typically used for retirement purposes to ensure you don’t run out of savings.
Types of Annuities
There are various types of annuities: fixed, fixed index, immediate, MYGA, and variable to name a few.
The type you select should depend on what you’re looking for and what you want your money to do for you: generating lifetime income, saving for retirement, or leaving money to your family when you pass.
However, annuities can be confusing because they are contract based, and contracts for types of annuities can vary. In addition, the fees, riders, taxes, and surrender penalties also vary.
This is why it’s imperative you read the fine print of an annuity contract before you sign on the dotted line.
The easiest way to understand a fixed annuity is to compare it to a CD (Certificate of Deposit) at the bank.
If you go to your local bank and you want to buy a CD, they offer you a fixed rate of return for a fixed period of time.
That’s what a fixed annuity does. Except the rate is typically much higher than a CD.
A fixed annuity offers you principle protection and growth potential based on a set rate.
It’s a popular product, especially if you want a guaranteed rate of return for a specific period of time. The longer you go into the set time period, the higher the interest rate will be.
Most fixed annuities have a guaranteed interest rate for the entire period. However, some fixed annuity products may have rates that change after the first year.
Fixed Index Annuity
Fixed index annuities offer growth potential based on the performance of an index, such as the S&P 500, for a fixed period of time.
With a fixed index annuity, you cannot lose your principal investment because it’s guaranteed by the insurance company.
The goal of a fixed annuity is to allow you to get better growth potential but without the risk of investing completely into the traditional S&P 500 index, which regularly fluctuates.
Let’s say the S&P 500 is 3,000 on the day you start your fixed annuity contract. 12 months from now, it’s at 3,100.
You will receive a percentage up to the cap or participation rate that’s declared in the contract – not the whole amount of what was actually earned in the annuity at the end of the 12-month period.
Should the S&P 500 index drop, you will not lose money because of what is guaranteed per the contract.
A fixed index annuity will only show you what your interest rate earned is at the end of the period.
The longer the duration of the contract, the higher the interest rate will be. The most common fixed index annuities are 3, 5, or 10 years.
Immediate annuities offer income payments that start within the first 30 days or, usually, within the first year of your purchasing it.
Immediate annuities are for the consumer who actually wants to earn income off of their assets. Or if a consumer needs a specific amount of income for a certain period of time.
I’ve actually seen consumers invest in this type of annuity when they are refinancing or buying houses.
Often, their income is not high enough to meet the debt to income ratio to purchase the home, but they have assets just sitting, doing absolutely nothing.
They take those assets, invest in an immediate annuity, and have an income stream that kicks out income to them on a monthly basis that the banks will use as mortgage verification.
Or people will use an immediate annuity to create lifetime income that they can never outlive. For example, if someone retires, they may roll over their 401(k) into an annuity.
Annuities are also being offered in many 401(k) plans. There is now a section that says, “This money will convert to X amount of dollars monthly for the rest of your life when you retire.”
You can set up immediate annuities for a set period of time or for your lifetime.
One common misconception is that, if you have an annuity with lifetime income, the insurance company just takes your money if you die prematurely.
This is not always the case. It ALL depends on the contract. Some of these contracts will allow you to have remaining funds go to beneficiaries.
A multiyear guaranteed annuity, or MYGA, is a type of fixed annuity that offers a guaranteed fixed interest rate for a certain period.
They are basically fixed annuities. The key difference is the terms of guaranteed rate.
A MYGA annuity rate is guaranteed for the full contract term. Fixed annuities offer a similar guaranteed rate, except that rate may go up or down after the first year.
A variable annuity is an actual investment product. This means it is tied to the stock market in one form or another, such as bonds, stocks, and mutual funds.
Because of this, they have a lot greater growth potential. And greater risk.
The difference between a fixed index annuity and a variable annuity is that with a fixed index, you cannot lose your principal investment. With variable annuities, you can lose your principal.
As with other annuities, you may select different contract durations when offered.