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The Annuity Guide

The Complete Annuity Guide

Annuities can be overwhelming so we have created our Annuity Guide to help you make the right choices when considering your retirement investment decisions.

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What Is An Annuity?

From Ancient Rome to Modern Retirement

Most people think of annuities as a modern income and investment vehicle. Nothing could be further from the truth. Although the annuity products of today differ quite a bit from their historical beginnings, the idea of paying out a flow or stream of income to a person or even a family dates back to the Roman Empire.

In fact, the word annuity comes from the Latin word "annua" which meant annual stipends. During the reign of the Roman emperors, the word indicated the existence of a contract that made annual payments — a clear link to the annuity income products offered today.

Today, annuity investments continue to grow in popularity and have proved their value as people look for more secure ways to guarantee their retirement income.

Fixed Annuity

An individual's funds are invested in an insurance company's general account. The insurance company assumes all investment risk — not the contract holder. Offers a guaranteed payment based on anticipated future returns and life expectancy.

Variable Annuity

Allows the contract owner to invest in both fixed-income and stock-based accounts. The value changes depending on investment performance. The contract holder assumes all the risk in exchange for the potential of higher long-term returns.

Definition

A financial product designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments at a later time. Most often used as a means of securing steady cash flow during retirement.

— AnnuitiesHQ Glossary & Terms

Annuity Types

Choose the Right Annuity for Your Situation

There are several different types of annuities for retirement available to investors today — each offering different benefits. Your financial needs in retirement are unique.

FA

Fixed Annuities

Guaranteed to return both the principal you invest plus a fixed rate of interest. Very similar to Certificates of Deposit (CDs), except a fixed annuity grows tax-deferred. One of the safest investment vehicles available.

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IA

Indexed Annuities

Combines features from both fixed and variable annuities. Your money is tied to the performance of a benchmark equity index, such as the S&P 500, with a minimum interest guarantee protecting your principal.

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VA

Variable Annuities

The most complex type of annuity. Allows you to invest in both fixed-income and stock-based accounts. The value will change depending on investment performance — the contract holder assumes all the risk.

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SP

Immediate Annuities

Also called a single premium immediate annuity (SPIA). When you purchase one, you enter into an agreement with an insurance company to purchase a guaranteed level of income on a predetermined schedule — beginning immediately.

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HA

Hybrid Annuities

Not your traditional annuity. Hybrid annuities are best suited to investors interested in preserving principal while participating in market upside. They borrow features from fixed, indexed, and variable annuities.

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How It Works

Three Phases of an Annuity

Annuities are easy to define at a basic level, but there is a great deal to know and to learn. Here is the core process every annuity follows.

1

Fund Your Annuity

You contribute a lump-sum payment or a series of periodic payments into an annuity contract during the accumulation phase. This may run for a period of 5 years, or as long as 25 years.

2

Let It Grow Tax-Deferred

Any funds you place into an annuity are not taxed until the time they are distributed to you. Your principal grows inside the contract — protected from the insurance company's investment risk in a fixed annuity.

3

Receive Your Income

At annuitization, you receive structured income payments — for a term certain, for your lifetime, or as a lump sum. Many annuities can be structured to provide guaranteed income for life, no matter how long you live.

Annuities 101

Top Ten Things You Need to Know

The most common questions people have when they first start considering an annuity — answered plainly.

1 What is an annuity? ▼
An annuity is a financial product sold usually by insurance companies to people who wish to make sure that they are going to have enough money to last them for the rest of their lives. For many individuals, this may mean a pension-type annuity called an immediate lifetime annuity — where, for a single lump-sum payment, the insurance company guarantees a certain monthly income for life. For another investor, a deferred annuity may be more appropriate, where contributions accumulate tax-deferred over a fixed number of years before being converted to income.
2 Why would I want an annuity? ▼
At some point, you will want to retire or at least reduce your working hours. These life changes will obviously have an effect on your level of income from employment. In the past, many of us could count on a company pension, but in recent times this is less and less likely. By working with a qualified financial advisor and doing your research, you may discover that there is an excellent, well-suited annuity that will help with your financial retirement needs — whether you want a steady monthly income or have taxation issues an annuity could help solve.
3 What are the different types of annuities? ▼
There are three basic types of annuities. The first is a fixed annuity — sometimes called a "traditional" or "immediate" annuity — which resembles a classic pension in its most basic form. The second is an indexed annuity, which offers the potential to earn more than a specified minimum interest rate because it is tied to a stock index such as the S&P 500, while still guaranteeing a minimum return if the index goes down. The third is a variable annuity, generally reserved for individuals with a higher risk tolerance, where the lump sum is invested in options chosen by the purchaser with no minimum interest rate guarantee.
4 Which annuity is right for me? ▼
There is no simple, universal answer. With a little work and the help of a trusted financial advisor, you should be able to find the annuity product most suited to your individual situation. We recommend you first establish your financial goals. You should only consider purchasing an annuity if you have fully funded — or intend to fully fund — your IRA, 401(k), or 403(b) for the year. However, if you have already taken care of those investments and still have funds to invest, an annuity can offer significant advantages to complement your portfolio.
5 What are some common misconceptions about annuities? ▼
Common misconceptions include: "I'll lose control of my money," "annuities are too expensive," "all the fees associated with annuities are too much," and "if I invest in an annuity, I can't invest in the stock market." These concerns are worth exploring with a licensed financial advisor, who can clarify what features apply to the specific product you are considering and what, if any, fees can be reduced or eliminated.
6 What are the fees associated with purchasing an annuity? ▼
Many annuity products do have certain fees and associated costs, however these can often be lessened or even eliminated with the help of your advisor. Note: you do not pay your financial advisor directly — the advisor is compensated by the insurance company. Common fees include costs for adding a spousal continuation rider, or for features that reduce your monthly payments in exchange for added protections. The fewer added benefits you include, generally the lower the cost.
7 What are the tax benefits of an annuity? ▼
Essentially, any funds you place into an annuity are not taxed — taxes are deferred — until the time the funds are distributed to you. When you begin to draw on the funds, you will pay taxes in one of two ways depending on how the original contributions were taxed. If you did not pay taxes on the funds used to purchase the annuity, the funds you draw out are taxed as normal income. If you used after-tax dollars to fund the annuity, you are only taxed on the interest your annuity has earned. Consult a tax professional for advice specific to your situation.
8 What do the ratings of insurance companies mean? ▼
There are several organizations that provide rating systems designed to help investors gauge the financial health of an insurance company. If a company has strong ratings from a number of different organizations, this means it is perceived to be able to fulfill its financial obligations. The four major rating agencies to check are: Standard & Poor's, Moody's, Fitch Ratings, and A.M. Best — the only one of the four focused solely on the insurance industry.
9 Can I change my mind after I've signed up? ▼
Yes — there is usually a "free look period," also called a "cancellation period" or "surrender period." This period normally extends 2 weeks from the date of contract signing but can sometimes be longer depending on the insurance company and your state. After this window closes, early withdrawals are typically subject to surrender charges. You should be certain you have carefully considered all your options before signing any contract.
10 What happens to my annuity when I die? ▼
This depends greatly on how your annuity is structured. If you die soon after payments begin, all payments from the annuity cease unless you selected a guaranteed period option. Selecting a guaranteed period ensures payments continue for the full term even if you die early — though it may reduce your monthly payout. Many annuities also allow you to structure the contract so a spouse continues to receive payments until their death, or so that a named beneficiary can inherit the remaining value of the annuity. Consult with a licensed advisor to structure your contract appropriately.
Keep Exploring

More From the Annuity Guide

Start Here

What Is an Annuity?

A plain-language explanation of what annuities are, how they work, and who they are best suited for.

Read the overview → Beginner

Annuities 101

A complete beginner's introduction covering the top ten things you need to know before purchasing an annuity.

Read the guide → Support

FAQ

Answers to the most common questions we receive here at AnnuitiesHQ — updated regularly.

View FAQ → Reference

Glossary & Terms

The most common terms and phrases used in the annuity business — defined in plain language.

Browse glossary →

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