Fixed & Variable Annuities

What is an Annuity Product?

An annuity is a contract between the annuity owner and an insurance company which provides tax-deferred growth from which regular income payments may be received at retirement. The owner agrees to pay a premium (either in a single lump sum or in periodic installments, depending on the terms of the contract). In turn, the insurer agrees to credit the premiums with interest and to convert the premiums and interest into a steady stream of payments to the owner by a specified date. Under federal tax laws, the owner does not have to pay any federal income taxes on the amounts earned within the annuity until he or she either takes withdrawals from it, or until the annuity is annuitized (converted into a stream of payments). Annuities are intended to be long-term investments that are often used to save for retirement.


Who�s involved in an annuity?

There are three parties to an annuity: the owner, the annuitant, and the insurer. The owner controls the contract, and can exercise contract provisions, such as withdrawals, designating beneficiaries, etc. The annuitant is the measuring life; for example, if the owner decides to annuitize, those payments may be made for the life of the annuitant, not the owner. Usually, the owner and the annuitant are the same person, but this is not always the case. The final party is the insurance company, which issues the annuity.


Types of Annuities:    

  • FIXED: In a fixed or fixed rate annuity, the insurer invests premiums in a portfolio of long term financial instruments, such as bonds and mortgages. Depending on the rate of return the insurer is able to earn on these investments, it will declare a rate which will be credited to all money invested in the annuity. These rates are generally not guaranteed (although there may be a minimum guarantee), and are subject to change by the insurer as changes in the earnings on its portfolio warrant. However, once a rate is credited to the value of the annuity, the annuity value will not go down even if the insurer’s underlying portfolio goes down in value. In other words, the insurer bears the risk of changes in market conditions.
  • VARIABLE:     The opposite is true with variable annuities. In a variable annuity, the owner can allocate premiums and cash values among several different funds or sub accounts. These sub accounts may include diversified stock funds, bond funds, money market accounts, or other more specialized types of investments. The important thing to remember is that the value of the annuity usually will reflect the performance of the underlying funds in which those values are invested; that is, the owner bears the market risk in a variable annuity. However, a variable annuity also has the potential for higher returns than a fixed annuity.

When do Annuities payments start?

In an immediate annuity, payments begin immediately or within one year from the date the annuity is purchased. There is no “accumulation” phase. Immediate annuities are often purchased on a single premium basis.

  • � A deferred annuity is a contract which allows the owner to annuitize more than six months after the annuity is purchased. The annuity thus has two phases: a “deferral” or “accumulation” phase and a “payout” phase. The annuity owner usually can access the annuity values during the accumulation phase by making withdrawals. However, withdrawals may be subject to surrender charges, and if made before age 59 1/2, to a 10% IRS penalty tax as well. Upon annuitization, the value that accumulated during the “deferral” (accumulation) phase may be applied to make payments under the payout option selected.


Should you consider purchasing an annuity?

Annuities should be considered by individuals with the need to accumulate funds for long-term goals. Because annuities offer the opportunity to take distributions either by withdrawals (deferred annuities only) or by annuitizing the contract, they are an excellent choice for retirement savings. They can also be used to manage a large sum of money (such as an inheritance or court settlement) for the long term.


What else I should know?

First, annuities generally have surrender charges, expenses, and contract fees. This usually makes them unsuitable as short term investment vehicles, since these costs will impact the value of the contract. Also, once annuitization begins, it is irrevocable.

Secondly, fixed annuities are backed by the insurance company that issues them. Although annuities are sometimes sold by banks, they are not FDIC insured, nor are they backed by the bank which sells the annuity.