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, starts out providing a guaranteed interest rate, typically for a guaranteed period, while also providing protection of principal. After the guarantee period ends or at the contract’s latest permitted annuity date, the annuity can be turned into a stream of guaranteed income for a period of time and/or a person's lifetime.
Fixed index annuity
An index 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 index-linked 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 index annuities; however, provide no downside protection of principal and full market risk exposure.. 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, do not have an accumulation phase and are designed to provide an income stream immediately or at a specified future date. Thus the income amount is not dependent on market or interest rate growth.
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?
Immediate – In an immediate annuity the purchase payment is turned into an income stream that starts immediately or no later than twelve months after contract issuance. There is no accumulation phase.
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 have the potential for growth depending on the type of annuity purchased.
Deferred income annuity — A flexible purchase payment annuity that provides a future guaranteed income stream either for a period of time or for life, depending on the annuity option selected.
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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