Many of the people I meet with own annuities. Most do not fully understand what they have. With hundreds of different annuities available, I’d like to shed a little light on the various types. All annuities are contracts with an insurance company.
Single premium immediate annuity, known as a SPIA, is an annuity that requires a lump sum premium to be deposited. It provides an income that could last the rest of your life depending on how you set it up. The major drawback of a SPIA is that your principle is gone and cannot be recovered except through future scheduled payments.
A fixed annuity resembles a bank CD. You put a lump sum in and the insurance company guarantees the principle along with a set rate of return. Although the rate of return is often lower than other annuities, because it is guaranteed, it provides a calculated way to determine what your money will do for you. Fixed annuities are very low-risk investments that are unaffected by the ups and downs of the stock market. They provide a guaranteed rate of return over the length of the annuity, typically ranges from three to 10 years.
Variable annuities are tied directly to the market and are subject entirely to the ups and downs of it. They have an option where you can guarantee an income, but do not protect your principle from loss. The rate of return is dependent on the performance of the market. The gains you may or may not accrue in a variable annuity are based on the performance of the underlying sub-accounts into which you allocated your premium. Sub-accounts are similar to mutual funds and usually reflect an investment strategy ranging from conservative to aggressive. It is important to understand that it is possible to lose your money in a variable annuity. Yes, your premium is at risk. If someone tells you that it is impossible to lose your money with a variable annuity they are misleading you.
Fixed-indexed annuities are a tax-favored accumulation product that can be funded with a lump sum premium or can be added to over time. Earnings grow on a tax-deferred basis. This means that you will not pay income taxes until you take money out of the annuity. This is especially important when you purchase an index annuity with after-tax funds. FIAs can also be purchased using funds transferred from a qualified plan like an IRA or a 401(k). This type of annuity allows you to participate in market gains, while protecting your principle from market loss. In fact, your principle is guaranteed to never lose money because of a market decline and therefore offers a high degree of safety. It’s important to note that your money is not actually invested in the market. It is simple tied to an index in the market. Many FIAs offer bonuses but often at the expense of lower potential gains.
Those are the four types of annuities in a nutshell. Within each type, there are many variations available to consider. While there are many benefits associated with owning an annuity, they are not right for everyone.
Holly Peterson is the owner of Elite Retirement Strategies and former radio show host. She is a professionally licensed insurance producer specializing in retirement planning and safe money solutions. As a regular seminar speaker she acts as a catalyst in helping others achieve their financial objectives. Holly serves all of Idaho. You can find her online at eliteretirementstrategies.com or by calling 208-252-4345.