Types of Annuities: Understanding the Differences

Types of annuities
Planning,opportunity, challenge and strategy

What is an Annuity?

Unlike a lot of other retirement funds, an annuity is a contract between you and an insurance company.

It pays out over time and serves as a great complement to an overall retirement strategy.

Retirement income annuities can provide a steady source of income during retirement. This income is not affected by how other retirement investments are performing.

There are many kinds of annuities. It is important to remember that the state you live in can affect your annuity options.

Here’s How an Annuity Works

You make a lump sum investment in the annuity, based on how much you want to contribute.

Choose a date or arrange multiple dates when you will receive your payout when you retire. Make sure these dates are suitable for you.

If you choose not to receive a lump sum payment, you can receive your income on a monthly, quarterly, or annual basis.

You can choose to receive those payouts for the rest of your life or for a certain period of time.

Couple researching the best annuities.

The length of your payment period will be a factor that determines the size of each of your payments.

The size of each payout will also depend on which type of annuity you choose. A fixed annuity will provide a predetermined payment amount.

Variable annuities and indexed annuities provide an income stream. This stream will change depending on the asset it is linked to. Its performance will affect the income.

Avoid Taxes While Your Annuities Accumulate

The money that you invest won’t be taxed during the period in which it accumulates.

Avoid bills from Uncle Sam. Watch your money grow year after year. Only pay taxes when you choose to receive the money as income.

You can save more money than usual with tax-deferred retirement accounts. This is a great way to build up your savings.

With other tax-deferred retirement accounts, including 401(k)s and IRAs, there’s a limit to how much money you can contribute annually. 

If you haven’t invested in retirement accounts, you won’t get the tax-deferred advantages they offer. You can’t invest all the money you want in this way.

Read this article to learn Five Simple Strategies to Maximize an Annuity’s Potential

Annuities Offer an Invaluable Alternative

With annuities, there is no annual contribution limit, making them especially advantageous if you are close to the retirement age. 

Having regular savings-generated payouts to rely on is critical because there’s no guarantee how individual stock investments will perform. 

Like these widely held S&P stocks that hurt many an individual investment portfolio in 2020… 

Occidental Petroleum Corporation (NYSE: OXY): Down 57.7%

Carnival Corp (NYSE: CCL): Down 57.2%

United Airlines Holdings Inc (NYSE: UAL): down 50.1%

Too many retirees are seeing the rug pulled out from under them, as their portfolios are laid bare in the midst of market uncertainty. 

Many Americans that had planned to retire are now seeing their retirements delayed, if not indefinitely postponed.

Historical Volatility

In today’s market background, there are no guarantees in traditionally advocated investment avenues. 

The stock market capsized in February of last year, only to quickly rebound and then adopt a pattern of volatility. 

Tucking guarantees into an investment plan is more and more important now, at a time when there are wild swings in the stock market.

Even Bonds Won’t Guarantee Smooth Retirement

Most traditional retirement portfolios feature a mix of both stocks and bonds. 

Bonds, while safer, have offered no better path into retirement. 

There are two main reasons investors have placed their confidence in bonds over the years. 

First, the prices of bonds suffer from less volatility than stocks. 

Second, they have traditionally offered an attractive fixed income return. 

But that is no longer the case. 

We’ve entered a new era of low-income bond yields. 

Bonds are generating near-zero income yields. 

10 Year U.S. Treasury Yield

The Federal Reserve has every intention of aggressively buying treasury bonds, which will cap bond yields over the short and mid-term future. 

Without enough yield, it’s become more challenging to hold a meaningful enough allocation of investment grade bonds, given that the expected return is too low.

In this era where traditional fixed income sources like bonds offer few benefits, annuities are an overlooked investment strategy. 

Does the State Which You Purchase an Annuity in Matter?

Sitting on the Sidelines Is Not The Answer

Fear is driving many retirees to display emotional behavior, making investment changes, even avoiding investments all together in favor of holding on cash. 

But cash offers no upside. It also poses the risk of overspending before or during the retirement years.

Benefits of Annuities at a Glance

There are 3 primary reasons why annuities are an attractive retirement strategy:

Lifelong Income Stream

With annuities, you can set up your retirement so that you never outlive your money. Though you can choose to receive annuity income for only a period of your retirement, most choose to arrange payments that cover them for the remainder of life. This is especially helpful for people of more modest means, as opposed to those with large nest eggs, because they can proceed into old age worry free, knowing that money in addition to Social Security can support them. 

Tax Deferral 

The opportunity to avoid paying taxes on large sums of money is one of the most attractive aspects of annuities. This is different from other retirement investments, such as certificates of deposit (CDs). With CDs, you are forced to pay taxes when they arrive at a certain maturity date.

In contrast, with annuities, you don’t pay taxes until you choose to withdraw the funds. At that point, the amount you contributed to the annuity is not taxed, but your earnings get taxed at your standard income tax rate. This gives you more control over the taxation process.

Overall, avoiding surrender charges is a key strategy when it comes to making the most of your annuity investment. Additionally, careful evaluation of the surrender period length, the type of annuity contract, and individual financial goals can all help make the decision to purchase an annuity easier. With proper planning and research, annuities can be an effective way to secure a stable source of income during retirement while minimizing tax liability. 

Fixed or Variable Rates

While all annuities can provide a steady and reliable stream of income into retirement, fixed annuities allow you to guarantee the precise income amount you will receive during that period whereas variable annuities can provide potentially higher income amounts during periods when the market performs well. Choosing between these types of annuities depends on the level of predictability they desire for their payouts.

What are the Different Types of Annuities?

Deferred Vs. Immediate Annuities

The two basic categories of annuities are deferred and immediate.
If you choose a deferred annuity, your money will be invested for a certain number of

years, usually until retirement, at which point you can begin withdrawing the money.

When you select an immediate annuity, you will receive payments immediately after you invest the money.

Deferred annuities are most common for people further from retirement age, whereas immediate annuities are for people who are about to retire.

The benefit of deferred annuity is that it allows money to accumulate over time.

Deferred annuities can be turned into immediate annuities when the retiree is ready to receive payouts.

These two categories of annuities include two sub-categories, fixed annuities and variable or indexed annuities, depending on predictability and growth preference.

Fixed vs. Variable and Indexed Annuities

Fixed annuities are different from variable and indexed annuities.

With fixed annuities, the insurance company agrees with the buyer upon a specific payment— at a future date or immediately, depending on the buyers preference.

The insurance company will then invest the money in a safe asset class, usually highly rated corporate bonds or U.S. Treasury securities.

For buyers with a higher risk tolerance, variable and indexed annuities can provide larger investment accumulation and higher regular payments.

Variable and indexed annuities, being tied to traditional higher growth assets, can offer the best of both worlds— a secure and safe regular payment combined with higher growth potential.

Variable annuities can provide higher upside because the insurance company will invest in a portfolio of mutual funds, which the buyer will select.

Indexed annuities can also provide higher upside because their growth corresponds to the performance of a particular market index, such as the S&P 500.

When those mutual funds or market indexes perform well, the buyer’s account will grow more and the payouts will be larger when they are eventually received.

Variable and indexed annuities require a greater tolerance for risk but can supply a larger profit.

Here the Spia annuity (Single Premium Immediate Annuity) is discussed in detail.

Main Annuity Types in Review

  • An immediate annuity is a lump-sum investment that starts to deliver payouts very shortly after the insurance company receives the funds.
  • A deferred annuity is a similar investment, except that the buyer selects a date in the future upon which payouts will begin.
  • A fixed annuity provides a predetermined payout amount, which will neither decrease or increase during the agreement term.
  • A variable annuity offers a scheduled payout that can nevertheless vary in amount, based on the performance of the underlying mutual funds it is tied to.
  • An indexed annuity is a fixed annuity where growth corresponds to the performance of a particular market index, such as the S&P 500. You are not “in” the index, but your interest is credited as a portion of the index movement. If the index losses money, your account is credited with 0%. You never lose any of your principal, interested previously credited or any of your locked in gains due to market fluctuation.

What Are Your Annuity Investment Options?

The answer to this question varies based on the type of annuity you choose. By choosing a fixed-rate annuity, you are placing the investment decision in the hands of the insurance company, as they will invest in corporate bonds or U.S. Treasury securities and agree to pay a predetermined rate of return.If you opt for a variable or indexed annuity, you have more control over how your money is invested. You can choose the mutual funds or indexes your annuities are tied to.

Get our 2023 Best Annuity Picks Here.