An annuity is a contract between you and an insurance company, in which you make a lump sum payment to set up your contract. In return, the insurance company agrees to make payments to you, either immediately or in the future either in payments or a lump sum walk-away value. Annuities also offer tax-deferred growth on your interest and most include a death benefit that will pay your beneficiary a guaranteed minimum amount, such as your total principle or principle plus gains less any withdrawals.
Types of Annuities
- Fixed Annuity–with a fixed annuity, the insurance company guarantees that you will earn a minimum rate of interest during the time that your account is growing such as a plan length of 3, 4, 5, 7, 10 years—much like Bank CD’s where the longer term you agree to, the more interest your will get on your money. Annuities are not FDIC insured like Bank CD’s, rather backed by the financial stability of the insurance company you choose so shop wisely. Also with fixed annuities, the insurance company will guarantee that periodic payments will be a guaranteed to the amount in your account at the time the request is made. These periodic payments may last for a definite period, such as 10, 20 years, or an indefinite period, such as your lifetime or the option of a lifetime payment to you and your spouse.
- Variable Annuities–a variable annuity offers a wide range of investment choices and the value of your variable annuity will vary depending on the performance of the investment options you choose. The investment options for a variable annuity are mainly mutual funds that invest in stocks, bonds, money market instruments, or some combination of the three. Although variable annuities are typically invested in mutual funds, variable annuities differ from mutual funds in several important ways:
Variable annuity will allow you to invest in multiple fund families inside your investment. For example, if the annuity you choose offers American Funds, Franklin Templeton, Fidelity, and MFS you could pick the top fund from each company as a way to diversify.
Variable annuities will also allow you receive a stream of periodic payments for the rest of your life or the even the life of your spouse, child, family member, friend, etc. (whomever you choose.) This feature in variable annuities offers protection against the possibility of outliving your assets after you retire.
Variable annuities have a death benefit built in so if you die before the insurer has started making payments to you, your beneficiary is guaranteed to receive a specified amount – typically at least the amount of your principle payments or principle plus any gains. Your beneficiary will receive this benefit even if at the time of your death, your account value is less than the guaranteed amount.
Variable annuities grow tax-deferred which means that you will pay no taxes on the income and investment gains from your annuity until you withdraw your money. You may also transfer your money from one investment option to another within a variable annuity without paying tax at the time of the transfer.