If you are new to the world of annuities, you might bump into some financial terms you’ve never met before. So we thought it’d be useful to explain some of the more common annuity language.
Before going over the terms, it’s important to understand what annuities are and what they do...
Annuities are financial contracts designed to help you accumulate assets on a tax-deferred basis and can provide a stream of income that cannot be outlived. That makes them a useful way to save for retirement or help reach long-term financial goals.
Annuities can also allow savings to grow faster because income taxes on the money in an annuity aren’t due until there’s a withdrawal. However, each type of annuity has advantages and drawbacks that should be considered carefully before purchase.
Let's start with a rundown of the types of annuities out there…
The simplest form of an annuity, a fixed annuity, guarantees a stream of fixed payments over a certain period of time and/or a person’s lifetime. Prior to this income phase, the insurance company credits interest that will never be less than the rate guaranteed by the annuity contract.
An indexed annuity links its return potential to market indices, such as the Standard & Poor’s 500 Index®. The performance of the index over a specific time frame will determine the interest credited to the annuity.
By guaranteeing that the credited interest will never be less than zero, the insurance company assumes the risk associated with negative index performance. However, the credited rate is typically limited in some way to help the company offset this risk. An index annuity offers the potential to earn more than a traditional fixed annuity, while offering some protection against loss.
Variable annuities offer a selection of underlying funds whose performance is driven by various investment markets.
Variable annuities offer more growth potential than fixed or indexed annuities; however, negative returns are also possible. Many variable annuities offer “riders,” which are features that can be added to provide additional benefits (at an additional cost). Some riders offer an enhanced death benefit, a guaranteed accumulation amount, or a guaranteed withdrawal amount – no matter what happens in the markets. However, there are typically requirements and restrictions around riders, so it’s important to understand them before adding them to an annuity.
In all the examples above, there is an accumulation phase where funds can grow and remain liquid until they are turned into an income stream or withdrawn. Income annuities, however, provide an income stream immediately or at a specified future date which is not dependent on the growth of funds during the accumulation phase.
Now, let’s take a look at some terms that get applied to the different types of annuities …
Deferred or immediate
You may also hear annuities being referred to as immediate or deferred: What’s the difference?
Deferred — A deferred annuity has an accumulation phase between the date the contract is issued and the date you begin receiving income payments. During this phase, your funds grow depending on the type of annuity.
Immediate – In an immediate annuity, the purchase payment is immediately turned into a stream of annuity payments. There is no accumulation phase.
Single or flexible premium
Single premium — A single premium annuity allows for only one purchase payment.
Flexible premium — A flexible premium allows you to add funds to the annuity after the contract’s inception date. As long as income payments have not started, you can continue to add funds.
In some cases, an annuity could have a modified flexible premium where multiple payments can be made but only for a set amount of time after the contract’s inception date.
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