Annuities

An annuity is a contract between you and the insurance company, where you make a lump-sum payment or several payments. The insurance company agrees to pay you periodic payments immediately or in the future. Annuities offer tax-deferred growth of earnings and also include a death benefit that pays your beneficiary a guaranteed minimum amount.

There are two types of annuities—fixed and variable. In a fixed annuity, the insurance company guarantees you a minimum rate of interest during the time your account grows. The insurance company also guarantees periodic payments will be a set amount per dollar in your account. These periodic payments could last for a definite period, such as 15 years, or an indefinite period, your lifetime or lifetime of you and your spouse.

By contrast, a variable annuity, allows you to invest payments from among a wide range of different investment options, typically mutual funds. The rate of return on your payments, and the credits you receive, will vary depending on the performance of the investment options you select.

Special types of annuities are Indexed or Equity annuities. When your money is in the accumulation period – you make either a lump-sum payment or several payments – the insurance company credits you with a return based on changes in an equity index, like the S&P 500 or NASDAQ Composite. The insurance company guarantees a minimum return. Guaranteed minimum return rates vary. When the accumulation period ends, the insurance company will make payments to you based on the terms of your contract, unless you opt to receive your contract value in a lump sum.

The Security Exchange Commission (SEC) regulates variable annuities as they are considered securities but fixed annuities are not securities and are not regulated by the SEC. Equity-indexed annuities mix features of insurance products (guaranteed minimum return) and securities (returns linked to equity markets). Depending on the combination of features, an equity-indexed annuity could be a security. Normally, equity-indexed annuities are not registered with the SEC.

Advantages of Annuities:

Tax-deferred growth and compounding interest within the annuity contract

Guaranteed rates of return

Guaranteed lifetime payments if you annuitize (sometimes, you don’t even have to annuitize to receive this benefit)

Insurance Companies that offer you strong guarantees usually have the best annuity products. You can mitigate risk by using strong insurance companies.

Disadvantages of Annuities:

You must pay for the guarantees somewhere in the policy. If you don’t need them, don’t pay for them. 

Some contracts have surrender periods that can tie up your money for long periods

IRS rules restrict how you withdraw money out of an annuity.

Distributions may be taxable and/or penalized.