People are confused about what are annuities because the very same word, "annuities," is applied to many types of financial instruments. This guide will hopefully end the particular confusion.
What are deferred annuities
Deferred annuities are term deposits with insurance companies. They are similar to certificates associated with deposits at the bank. (Take note: Bank deposits are FDIC-insured although annuities are guaranteed by the insurance company). There are two types of annuities: fixed and variable.
What are fixed annuities?
Fixed annuities have these traits:
- Your principal is guaranteed. It's going to never decline (although it could be impaired by surrender charges--the term the insurance industry uses for early withdrawal penalties).
- The insurance company provides interest to your deposit each year (according to the formula, the interest added could possibly be zero, but most every company offers a minimum annual guarantee).
- The annuity is for a specific time period that you select -generally, the longer the period, the higher the interest. Typical terms are from 5 years to 15 years.
- All interest is tax-deferred. You do not document it on your tax return until withdrawn.
- You may withdraw 10% of one's balance annually without any surrender charge. This 10% figure is a common feature, and your withdrawal privilege will vary at each annuity company.
- Most fixed annuities offer an original one-year rate with the rate changing each year. A couple of companies offer a locked-in rate for the entire period, called multi-year guarantee annuities.
So far, have we partially addressed your question,"what are annuities?" Wait, there's more!
What are variable annuities?
A different type of annuity is called a variable annuity. With this type of annuity, rather than getting interest from the insurance company, your money is placed into investment account that you select. With a variable annuity, you can earn greater than a fixed annuity, or you could lose principal, according to the accounts you select; and if the stock and bond markets rise as well as fall. Variable annuities are therefore riskier as compared to fixed annuities.
What are indexed annuities?
There has been significant growth in buying of indexed annuities, a type of deferred fixed annuity. In this type of annuity, your own principal is guaranteed such as the fixed annuity, but your interest each year is based on appreciation in a financial index (for example, the S&P Five Hundred stock market index). So, your interest will be tied to performance of the index, however, you can never lose principal due to index performance. (You can lose due to surrender charges if you make withdrawals prior to the end of the annuity term). Index annuities are generally susceptible to a lengthy surrender charge periods. Moreover, purchasers of an equity indexed annuity do not get the entire rate of return from the related index, as there may be a cap or perhaps a limit on participation in the index. Further, these types of annuities generally guarantee some minimal rate of return, such as 2.5% annually, should the S&P 500 index not appreciate during the term of your contract.
Still curious to learn more? We will add to your education as to what are annuities.
What are deferred annuities?
Everything discussed up until this aspect describes the growth phase (referred to as accumulation phase) of the annuity. The deferral or accumulation phase typically interests men and women saving for retirement or placing money away for the future. During this growth phase, your interest grows tax-deferred within the annuity. Withdrawals are taxable. Deferred annuities may be fixed or variable.
Whenever and how do you get your money out? After the term, you have a few alternatives:
What are annuities payout phase about?
You can leave the annuity as is and continue to let it grow. Several companies may force you to take distributions or annuitize at a specific time, typically age 85.
You can exchange the annuity to an alternative company that may pay you a higher rate, or perhaps offer you a preferable structure.
You can make withdrawals as you desire and leave the annuity as an "open account"
You can annuitize the particular annuity - trade in your gathered balance for periodic payments for the specified term of decades or life (this is called "annuitization)"
The withdrawal cycle is called the distribution cycle. This phase is of interest in order to retirees.
What are annuities--immediate annuities?
Immediate annuities, unlike deferred annuities, have no accumulation phase. You create a deposit with the insurance company and immediately start off receiving payments. These annuities are generally suited for mature investors (age 70+) who desire to increase their month to month income.
Has this helped? Do you feel you have a good answer to what are annuities? Annuities retain significant flexibility because of the various kinds, and the various ways that they could be used.
albert @esl activities says
Thank you for explaining the different types of annuities. Good to know that your principal is secure with a fixed annuity.
Your Own Retirement says
Annuities can be an amazing tool to earn a significant yield on your investment but you have to know which annuity is right for you.