An Annuity is an insurance product that pays out income and is often used as a retirement strategy. It is a contract designed to accumulate money. The money may then be totally or partially with drawn or systematically liquidated over a period of time. The pure annuity concept involves the systematic liquidation of a sum of money over a person’s life expectancy.
Annuities work like this: you make an investment in the annuity, it then makes payments to you in the “Annuity Period” on a future date or series of dates. The income from the annuity can be given out monthly, quarterly, annually or in a lump sum payment. The size of your annuity payments are determined by a variety of factors, including the length of your payment period, also known as the “Accumulation Period”. You can choose to receive payments for the rest of your life or for a set number of years. How much you receive depends on the type of annuity you choose to invest in (Fixed, Variable or Indexed).
There are many different terms used and investment options when choosing an annuity:
- Owner: the person who possesses the contractual rights in an annuity. The owner is usually the annuitant.
- Annuitant: the person on whose life expectancy the annuity payments will be based. The annuitant is typically the owner of the contract.
- Beneficiary: the person designated to receive any remaining benefit at the death of the owner and/or annuitant.
- Insurance company: the issuing insurance company.
- Definition: the period during which the annuity owner makes payments to the insurer.
- Single premium: one payment.
- Level premium: a series of equal payments over a specified period of time.
- Flexible premium: payment amount and frequency may vary at the discretion of the owner. The insurer may impose minimums and maximums.
- Definition: the period during which the insurer makes systematic payments to the annuity owner.
- Immediate: annuity payments begin within the first contract year.
- Deferred: annuity payments do not begin within the first contract year.
- Fixed annuity: Guaranteed payout. Earnings are in the form of interest with a minimum guarantee. Payments made to the owner during the annuity period will also have a minimum guarantee. When naming a specific type of annuity, fixed investment basis is usually assumed unless otherwise stated.
- Variable annuity: Payout stream determined by the performance of your annuity’s investments. Earnings will be based on the value of an underlying investment portfolio chosen by the owner (stocks, bonds, money market, etc.). Many contracts do not have a minimum guarantee on accumulation values or annuity payments.
- Indexed annuity: Combination of fixed and variably annuity. Tax deffered payout is based on index (i.e. S&P 500) performance during a specific period (month, year, or more). Earnings are based on the crediting of interest based on movement of an external equity index. The value of the index is tied to a variety of outside indicators: stocks, bonds, dow, t-bills, ect. The value varies from day to day and is not predictable. The Indexed Annuity protects principal from market risk but provides the opportunity for a higher rate of return than would be possible from a traditional fixed annuity or other long term savings vehicles.