One of the reasons annuities have so many different features is that they are actually contracts between an annuity holder also known as an annuitant and an insurance company. Contracts have different provisions, different costs, different payouts, etc. The upside is an annuity can be personalized to fit your needs. The downside is the vast array of options can seem overwhelming to potential annuitants.
Annuities are contracts issued and distributed (or sold) by financial institutions where the funds are invested with the goal of paying out a fixed income stream later on. They are mainly used for retirement purposes and help individuals address the risk of outliving their savings. Upon annuitization, the holding institution will issue a stream of payments at a later point in time.
Fixed, variable and fixed indexed are the main types of annuities. Knowing what level of risk you’re comfortable with will help guide you through your annuity choices.
Interest-rate risk is a factor in determining the calculation of your payments. Low risk yields predictable payment amounts. Higher risk could boost your expectations.
|Variable||Tied to investment portfolio||Higher||Potentially higher or lower|
|Fixed Indexed||Preset minimum. Can change according to index like stock market||Medium||Won’t sink below set level.|
This is the option with the least risk and the most predictability. Fixed annuities come with a guaranteed, set interest rate that doesn’t vary beyond the terms of the contract. While other investments might soar or dive, the fixed annuity is steady. Sometimes, however, the interest rate will reset after a predetermined number of years.
Types of fixed annuities
An equity-indexed annuity is a type of fixed annuity, but looks like a hybrid. It credits a minimum rate of interest, just as a fixed annuity does, but its value is also based on the performance of a specified stock index usually computed as a fraction of that index’s total return.
A market-value-adjusted annuity is one that combines two desirable features the ability to select and fix the time period and interest rate over which your annuity will grow, and the flexibility to withdraw money from the annuity before the end of the time period selected. This withdrawal flexibility is achieved by adjusting the annuity’s value, up or down, to reflect the change in the interest rate “market” (that is, the general level of interest rates) from the start of the selected time period to the time of withdrawal.
A variable annuity comes with more risks and potentially higher rewards. The interest rate of variable annuities is tied to an investment portfolio. Payments from variable annuities can increase if the portfolio does well, but they can also decrease if the investments lose money.
With a variable annuity, the insurer invests in a portfolio of mutual funds chosen by the buyer. The performance of those funds will determine how the account grows and how large a payout the buyer will eventually receive. Variable annuity payouts can either be fixed or vary along with the account’s performance.
People who choose variable annuities are willing to take on some degree of risk in the hope of generating bigger profits. Variable annuities are generally best for experienced investors, who are familiar with the different types of mutual funds and the risks they involve.