Types of Annuities
Are annuities a form of life insurance?
No. Annuities are fundamentally different in the sense that an annuity does not provide any life insurance coverage. Instead, what it offers is a guaranteed income either for life or a certain period. Annuities are also called pension plans as they are bought to generate income during an individual’s retired life.
Life insurance protects the loved ones of the policyholder in case the holder dies before his or her financial obligations towards them are met whereas annuities protect the annuity owner against the possibility of outliving his or her assets.
What are the different types of annuities available to me?
Fixed annuities are a fairly good financial instrument for persons wishing to receive a fixed investment income. In fixed annuity, annuity owners are guaranteed the principal and a fixed rate of return. Fixed annuities are invested primarily in high-grade corporate bonds and government securities.
Let’s take an example: Jane chooses a fixed annuity for a 20-year time period, called the ‘surrender period’. The insurance company assigns a rate of return and this rate of return remains unchanged during the entire 20 years. Because she knows how much she will draw every month, it’s very much like a monthly salary. However, she cannot withdraw any part of her invested amount during the surrender period, without some penalty. Types of fixed annuities include:
- Market Value AdjustmentA market value adjusted annuity is one that possesses the ability to select and fix the time period and interest rate over which the annuity will grow and the flexibility to take out money from the annuity before the end of the time period selected. However, there is no guarantee of funds if rates are high and the contract needs to be ended or surrendered.
- Guaranteed ReturnThis is a fixed annuity that offers the guarantee of receiving almost 100% of the investment funds. The interest rate does not vary and the contract can be surrendered if one’s initial investment gets depleted with the changes in the market.
In this case, the amount an annuity owner receives is not guaranteed as it is determined by the performance of the stock and bond markets. Individuals who want to invest in a specific fund or into sub-accounts can go for variable annuities. Variable annuities make sense for a person who wants gains of potential market growth and has significant assets to set aside for 10 years or more. They may also be attractive to a person who makes lots of money and is trying, probably late in the game, to save aggressively for the retirement. The main selling point of a variable annuity is that the underlying investments grow tax-deferred, as in an IRA. Any gains (appreciation or interest) from the annuity are not taxed until money is withdrawn. Variable annuities, although having no predetermined rate of return, offer a potentially higher rate of return when compared to a fixed annuity.
An example: Jane buys a variable annuity that involves a range of investment options, and the rate of return is tied to internal mutual funds. As these funds depend on financial market conditions, they can go up or down, thereby making the rate of return unstable