Annuity Basics

Annuities

An annuity is a retirement planning tool designed to protect against the risk of outliving one's resources. Annuities are one of the few investments that allow your money to grow tax deferred. When you buy an annuity, you agree to make payments to the insurance company in exchange for which the company agrees to make payments to you at a later time for a specified period.

The period in which you pay premiums is the accumulation period; premiums are paid as one lump sum or in installments over a period of time. When the accumulation period is over, the company begins distributing your funds. Distribution of the funds is known as the payout period. You can receive your distribution in one lump sum, or choose to receive a steady stream of income throughout retirement.

Fixed or Variable Annuities

There are two basic types of annuities: fixed and variable annuities. With fixed annuities, the insurance company invests your premium in its general account and your cash value earns a fixed rate of return. Whatever payout option you select, the interest gains and payment amounts are guaranteed by the insurance company, which assumes the risk of investing the general account. You are guaranteed a fixed payout when you begin to receive your annuity income.

Variable annuities provide a variable rate of return. Your premiums buy units in your choice of separate accounts, which then invest in stocks, bonds, and money market funds. Your payout will depend on performance of the investment portfolio you select in which your premium is invested. Unlike fixed annuities, the value of your account is not guaranteed—a variable annuity offers more growth potential and investment choices than a fixed annuity, but also carries more risk.

Immediate or deferred

There are two main payout types for annuities: immediate or deferred. An immediate annuity provides income payments right after the initial annuity payment. You choose whether income is guaranteed for a specific number of years or for your lifetime. The insurance company calculates the amount of each income payment based on your purchase amount and your life expectancy.

The deferred annuity delays annuitization and has two phases: the accumulation phase and the payout phase. A deferred annuity provides more time and opportunity for your money to grow tax deferred.

During accumulation, your money grows tax-deferred until you take it out, either as a lump sum or as a series of payments. You decide when to take income from your annuity and therefore, when to pay the taxes. Gaining increased control over your taxes is one of the key benefits of annuities.

The payout phase begins when you decide to take income from your annuity. For most people, this is during retirement. As your needs dictate, you can take partial withdrawals, completely cash-out (surrender) your annuity, or convert your deferred annuity into a stream of income payments (annuitization). This last option is essentially the same as buying an immediate annuity.

Payout options available for annuities:

• The annuitant can receive all of the funds at once in a lump sum payout.
  
  
• Lifetime Income for You. This option provides lifetime regular income for the rest of your life. Payments cease upon your death.
  
  
• Lifetime Income with a Guaranteed Period. You will receive income for life. If you die before the guarantee period is over, your beneficiaries will receive the remaining number of payments.
  
  
• Lifetime Income for Two. This payment option guarantees income payments for the life of the annuitant and a beneficiary, such as a spouse. Known as the joint and survivor annuity option, it guarantees that income payments will continue for the life of the primary owner and a second person.
  
  
• A period certain annuity provides regular income for a fixed period of time, such as 10 or 20 years, whether or not the annuitant dies.
  
  
  

Which type of annuity is right for me?