Common types of annuities
Though annuities can come in many different shapes and forms, there are some common definitions of categories and types. In exchange for premiums paid, the insurance company promises the investor periodic payments over time, beginning either immediately or after some accumulation period. The first is known as the immediate annuity. Generally, investors purchase an immediate annuity with a lump sum payment. The second refers to a deferred annuity; most deferred annuities allow for either lump sum or periodic payments.
An annuity generally has two phases: accumulation and annuitization. During the accumulation period, an investor deposits funds into the account. At the end of the accumulation period, the investor can choose to annuitize the funds, meaning converting the deposited funds into periodic payments.
FIXED ANNUITIES:
Fixed annuities generally guarantee a fixed or minimum rate of return over a specific time period. However, most annuities reset the fixed rate of return at the end of each pre-determined time frame, known and a term. Terms vary across companies and policies, but are generally one year. A fixed annuity contract can be compared to buying bank Certificates of Deposit (CD’s).
VARIABLE ANNUITIES:
Variable annuities allow premiums to be invested in a limited number of sub-accounts, similar to mutual funds. These sub-accounts may be invested in stocks, bonds, or even cash. Variable annuities may also offer a guaranteed minimum rate of return, even if the underlying investments under perform. As with all annuities, funds grow tax-deferred during the accumulation period, but the growth is taxed as ordinary income upon withdrawal.
EQUITY-INDEXED ANNUITIES:
Equity-indexed annuities contain features of both fixed and variable annuities. Equity-indexed annuities offer investors a return based on changes in a specific market benchmark, such as the S&P 500.