When you purchase an annuity, you pay a premium either in a lump sum or multiple installments. Your annuity provider takes your premium payment and the premiums from other annuity contracts and invests them.
Insurance companies are what are referred to in the investment world as “institutional investors.” Institutional investors invest huge sums of pooled money in stocks and bonds to generate returns large enough to allow them to pay out the income streams they guarantee.
An annuity fund is essentially the portfolio of investment options that providers invest annuity premiums in to generate growth on the annuity contract. The type of investments the insurance company puts your money in depends on the type of annuity you purchase.
Key Facts About Annuity Funds
- Insurers invest premiums from annuity contracts into annuity funds that generate growth for those contracts.
- A fixed annuity fund consists of low-risk investments like corporate or government bonds, which produce reliable returns.
- Variable annuity funds contain a variety of security investments and have a higher growth potential but lack principal protection.
- Annuity funds determine your rate of return and, ultimately, your guaranteed income payment amount.
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Fixed Annuity Funds
Fixed-rate annuities provide a fixed payment amount determined in part by the level of risk the company is assuming, as well as the performance of the fixed securities market and the annuitant’s life expectancy.
Most fixed annuity premiums are invested in high-quality corporate bonds. Annuity providers ensure that the cash flow received from these bonds matches the obligations of their annuity contracts. In this case, cash flow refers not only to the bonds’ interest payments but also to the repayment of the principal investment when the bond matures.
The maturity of the bonds in a fixed annuity fund affects the annuity’s surrender charge schedule. Insurers use the surrender period to discourage annuity owners from cashing out their contracts before the bond investments in the fund have matured. For example, if a large portion of the fixed annuity fund is invested in government bonds with a 10-year term, the provider might include a 10-year surrender period in their fixed annuity contracts.
Fixed annuity funds have lower risk and lower growth potential. Although the fund won’t generate returns as high as a more aggressive portfolio might, your money is safe, and the insurer will typically guarantee a minimum interest rate for the life of the contract.
Variable Annuity Funds
Variable annuity funds are less stable because they consist of market-based investments. Because insurers invest variable annuity premiums in securities, variable annuities are required to be registered with the Securities and Exchange Commission.
When you purchase a variable annuity, you can direct your premium to be invested in one or more subaccounts. These subaccounts work like mutual funds and make up the portfolio of your variable annuity fund.
The insurance company gives you control of the subaccounts, allowing you to choose from a selection of bonds and stock options, including money market funds, mutual funds and bonds.
Since variable annuities are tied directly to the performance of the stock market, your rate of return can fluctuate, meaning it is possible for an annuity holder to lose money with a variable annuity.
| Fixed Annuity Fund | Variable Annuity Fund |
|---|---|
| Fixed-rate investments | Market-based investments |
| More stable | More volatile |
| Minimal returns | Potential for greater returns |
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Frequently Asked Questions About Annuity Funds
Variable annuity premiums are placed in subaccounts, which are investment portfolios that can accumulate value for the annuity contract. The average variable annuity has 52 subaccounts to choose from.
Fixed annuity premiums are invested in portfolios of high-quality, low-risk investments such as corporate bonds.
Insurance companies pay annuities in a variety of ways, including free withdrawals each year, a lump sum when the annuity matures, or a stream of income payments. The income stream can be arranged to last for the annuitant’s lifetime or their and their spouse’s lifetime. If the annuitant dies before the annuity finishes paying out, the insurance company pays the annuity’s remaining value and any death benefit included in the contract to the named beneficiary.
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