Types of Annuities >

Some people like the idea of receiving a guaranteed check every month to fund their retirement. One way to buy your own pension is to purchase an annuity.  There are several Types of Annuities and each offer specific and unique options that can be used to meet our unique funding needs.

Types of Annuities #1- Immediate Annuity

Immediate Annuities (AKA income or payout annuities) are for the most part a life insurance policy. With life insurance we pay premiums to our insurer who pays out a lump-sum payment when we die. But with an annuity we give the insurer a lump sum of cash in trade for regular income payments until we die.

There are several Immediate Annuity payout options:

  • Payments for a specified period of time, i.e. 10, 15, or 20 years
  • Payments that will be paid out for as long as you live. There is the option to take lower payments to have a survivor benefit. Then it pays out as long as you or your spouse is alive.

Immediate Annuities start paying out right away, “IMMEDIATELY”. They are often the annuity of choice by people who are already in retirement.

Types of Annuities #2- Deferred Annuity.

A Deferred Annuity is where your money is invested by the insurance company for a period of time until some future date. The future date when you are ready to begin taking withdrawals. One thing to note is that a deferred annuity can be changed to an immediate annuity at any time.

Immediate and Deferred annuities can also be either fixed or variable which means it depends on whether the payout is tied to the performance of the investment markets, a fixed sum, or a combination of both.

Types of Annuities #3- Fixed Annuity.

Fixed Annuities are pretty much insurance company issued CD-like investments. They will pay guaranteed rates of interest. A Fixed Annuity can either be immediate or deferred. The immediate variety makes fixed payments. While the deferred type will accumulate regular rates of interest. Your payment amount during retirement is determined by your age when payments begin and the amount of money you invested in your annuity.

The Fixed Annuity’s advantage is they pay guaranteed rates of interest making them attractive to risk averse people fearful of the stock market’s ups and downs. They also have low investment minimums. Usually in the $1,000 to $10,000 range. The interest that they pay isn’t taxed until it pays it out.

The Fixed Annuity’s disadvantage is their rates can be fixed for only a limited time-frame and then drop lower in a following year. You are pretty much locked into the contract. If you want to pull out of the annuity early there are very large surrender charges.

The biggest issue with the fixed lifetime payments is that the payments will not rise with inflation. The result is your buying power of the money you receive declines in value over time. This can be a large concern to someone who retires early and uses a fixed lifetime payment annuity to fund their early retirement.

Types of Annuities #4- Variable Annuity

A Variable Annuity is tax-deferred and allows you to choose from a variety of investments. It then pays you a level of retirement income determined by the performance of the investments you chose. The selected investments reside in sub-accounts consisting of mutual funds that are offered inside the annuity. They are designed to give you the chance of long-term capital growth. The gains they pay isn’t taxed until it pays it out to you. The growth potential of a variable annuity it is expected to outpace inflation.

Variable Annuities do have a downside that can take away from their advantages. That being Investment risk. If your chosen investments within the annuity decrease, your annuity value will also decrease. Meaning a lower payment to you. There is also a tax annoyance. Your long-term capital gains built up in stock and bond annuity subaccounts are taxed as ordinary income when paid out. Meaning long-term capital gains have been converted into ordinary income at higher tax rates.

Adding to the tax issue are the fees. There are sales commissions (often 4%), continued management fees and insurance charges, which together can be as high as 2% to 3% a year. This is why people aren’t so warm to annuities when you compare annuity costs with regular no load index funds which normally have annual costs of less than 0.50%.

Types of Annuities #5- Equity Index Annuities.

An Equity-Indexed Annuity is a combination of a fixed and a variable annuity. The sales pitch is Equity-indexed annuities give you the best of both worlds. The guaranteed return of a fixed annuity with some potential for upside. Its investment return is also tied to the performance of a benchmark index, like the Standard & Poor’s 500.

The unfortunate reality is that equity-indexed annuities are very complex investment vehicles. Their complexity makes them extremely confusing and difficult to understand which means the marketing pitches can be deceptive. The different equity-indexed annuities calculate gains in different ways. They may give only a portion of the index’s overall return, set an annual cap and exclude any dividends.

Once again there are fees and for some Equity-Indexed Annuities the surrender charges can run as high as 20% and lasting for 15 or more years. To have access to all of your money means being charged high surrender penalties in effect for a very long time.

Types of Annuities #6- Longevity Annuity.

A Longevity Annuity is a kind of deferred annuity. It’s meant to protect you from outliving your money late in your life. They are also known as an advanced life delayed annuity. This kind of annuity requires you to wait until you reach age 80 or so before receiving a payment. Once the payments begin it provides a guaranteed and regular amount for the rest of your life.

You are basically insuring yourself against running out of money while keeping your premium cost to a minimum. Common advice is to only invest a portion of your retirement nest-egg in a longevity annuity. No more than 10% to 25% of your portfolio and leaving the rest of your retirement savings in your other retirement accounts. There is a good reason why you should only put a small portion of your money into a Longevity Annuity. If you die before you begin receiving income, your entire annuity account will be lost to the insurance company. That is why they are affordable.

Also of note is that in 2014 a new type of no annual fee Longevity Annuity called a QLAC (Qualified Longevity Annuity Contract) was created by the US Treasury. QLACs have some unique benefits. Check out my page on this if you are interested.

In Closing

As you can see there are many types of annuities to consider as part of your retirement funding strategy. That is if you are in the annuity market.

Do your research, read the fine print, and get advice from someone with annuity knowledge that you can trust. In the mean time there is a free annuity online calculator where you can see what kind of annuity payouts you may expect.

Annuity Calculator.

QLAC (Longevity Annuity) Calculator.

 


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