Before purchasing an Annuity it is important to understand the differences among various annuities.  This will help you choose the correct annuity to fit your needs.  The information on this page focuses on fixed deferred annuity contracts. This information isn’t meant to offer legal, financial or tax advice.  Please consult an independent financial advisor or qualified insurance agent before making an annuity purchase.

What Is An Annuity?

An Annuity is a contract in which you receive regular monthly or annual payments from an insurance company that are based on the premium or premiums you have paid and life expectancy at the time of annuitization*.   Most annuities are bought to create a future retirement income stream.  The primary benefit of an annuity is the fact that it's the only financial instrument that can GUARANTEE you an income for as long as you live.  Annuity benefits are based on interest rates and mortality tables the same way that life insurance benefits are calculated, so most insurance companies offer both life insurance and annuity products.

* Annuitization is the act of taking a lump sum of money and calculating a stream of payments.

Immediate Annuity Vs. Deferred Annuity

An Immediate Annuity is when a lump sum is placed into an annuity account and the Insurance Company begins making payments on a regular basis ( usually monthly or annually ).  Payments on an immediate annuity must begin within 1 year of the premium payment.  The amount of the payment is based on several factors such as the life expectancy of the individual, assumed interest rates and the terms of the contract.   The original annuity concept would simply guarantee an income stream for the remainder of the life on one individual.  However, the terms of the contract do vary by product and by company so there are options such as guaranteed payout periods (commonly 10 or 20 years) or joint benefits between a husband and wife which would be based on the life expectancy of both individuals.

A Deferred Annuity means that you pay premiums now with the intent of letting the money grow before you begin receiving payments.  You may choose a Single Premium Annuity or a Multiple Premium Annunity where you make scheduled payments over time.  Single Premium Annuities are often used in situations where a individual has a "one time windfall" they want to invest.  Whereas, multiple premium annuities are commonly used when an individual wants to invest on a regular basis over a number of years.

Tax Benefits Of Deferred Annuity

The primary reason people invest in deferred annuities is because the money accumulates on a Tax Deferred basis.  This means that your money can compound on an annual basis without incurring tax withdrawals and you don't pay taxes until you begin to draw out the money.  At that time you pay taxes on the amount of the gain which is the money accumulated less the money invested.

Guaranteed Income Stream Benefit

Another primary reason why people choose to use annuities is the guaranteed income stream over their lifetime.  This provides a level of comfort and security when you know you will receive the same amount of money each month or year for the remainder of your life.

Fixed Annuity Vs. Variable Annuity

During this accumulation phase you may choose between fixed, variable or indexed products.  In a Fixed Deferred Annuity your money  minus any applicable fees, earns an interest rate set by the insurance company or spelled out in the annuity contract. These interest rates change from time to time with market rates and are set by the company, current rates typically change on a monthly basis and vary by product.  When you look at an illustration or statement you will normally see the current interest rate for the latest period as well as the guaranteed minimum interest rate the company is willing to pay throughout the accumulation phase of the contract.  During the payout period, the income payments will generally be fixed as well and will not change.

During the accumulation period of a Variable Annuity, the insurance company puts your premiums minus any applicable charges or fees into a separate account. The individual decides how the company will invest those premiums, depending on how much risk you want to take. The options include putting your premiums into a stock, bond, or other account, with no guarantees.  You may also choose to move your money into a fixed account with a guaranteed rate of interest.  During the payout period of a variable annuity, the amount of each income payment to you may be fixed (set at the beginning) or variable, changing with the value of the investments in the separate account.

Fees and Charges

Most annuities have selling and servicing costs that are recouped through charging fees.  These charges may be subtracted directly from the cash value of the contract.  Ask the insurance agent or financial advisor to describe the charges that will apply to the particular annuity you are considering.

Surrender Or Early Withdrawal Charges

The most important fees to understand are the surrender and early withdrawal charges.  Most products will give you limited access to your money ( 10% per year for example ) but will charge substantial penalties for any withdrawals over that amount.   Surrender charges are typically on a sliding scale and normally disappear altogether after several years.  However, since surrender penalties can last for several years, you will want to make sure you understand them before entering a contract.

Free Look Provision

Many states have laws that require the company to give an individual a set number of days to look at the annuity contract after you buy it.   If you decide during that time that the annuity isn't right for you, simply return the contract and receive all your money back. This is often referred to as a free look or right to return period. The free look period should be prominently stated in your contract.  Take the time to review your contract and ask questions during the free look period.

Additional Information Sources:

Free Financial Coaching - Bruce Hager "The Money Coach"

Free Annuity Buyers Guide From the National Association Of Insurance Commissioners

Additional Annuity Videos - Compiled from YouTube and organized by topic.