There are two types of deferred annuities: fixed and variable. An insurance company invests monies from fixed annuities in bonds, while variable annuities are tied to stocks, mutual funds, commodities and other market indicators.
Annuities are investments that can ensure long-term growth while preserving the underlying principal. There are several types of annuities to choose from, allowing you to find one that will be most effective in furthering your financial goals.
Two types of annuities are fixed and variable. Each has its own risks and benefits.
With a fixed annuity, your premium is placed in the insurance company’s general account and that money is mostly invested in different types of bonds. A variable annuity is connected to the performance of another financial instrument, such as stocks, mutual funds, precious metals or commodities.
Both fixed and variable annuities can be immediate or deferred annuities. Annuitants with immediate annuities begin to receive payments from the annuity shortly after purchasing it. Annuitants with deferred annuities don’t begin receiving payments for many years or even decades after they purchase the annuity.
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Fixed annuities offer a guaranteed payout because they have a set rate of return. For the first year of the annuity, the rate is fixed. After that, the insurance company can raise or lower the interest rate on a yearly or multi-yearly basis, but not below a guaranteed minimum. There is no upper limit on contributions, and taxes on the growth are deferred until withdrawal.
Fixed annuities come with a guarantee that you cannot lose your principal unless the insurance company fails.
If you are older than 59½, you can make annual withdrawals of up to 10 percent of the account’s value every year with no penalty. Those under age 59½ pay a penalty to the IRS for early withdrawals.
Fixed annuities have several payout options, including lump-sum withdrawals, periodic withdrawals or a combination of the two.
Although they are considered a low-risk option, there are some risks associated with fixed annuities:
Fixed annuities, in general, are not known for carrying a number of fees. Still, there are some fees that can be tacked on to any type of annuity. Such fees include:
Variable annuities are structured around the stock market and other fluctuating financial instruments, and therefore can vary in profitability. When you purchase a variable annuity, your premium is distributed into various sub-accounts that align with your preferred level of risk.
The value of your variable annuity will depend on the performance of the investment options you choose.
Similar to fixed annuities, variable annuities grow tax-deferred, have no upper limit on contributions and offer different payout options. Just like fixed annuities, variable annuities can pay out in a lump sum, in smaller payments over time, or a combination of both.
One benefit of variable annuities is they let you receive period payments for the rest of your life or the life of a beneficiary such as a spouse. This protects you against the possibility of outliving your investments. The other advantage offered by variable annuities is they come with a death benefit. If you die before payments have started, your beneficiary will receive a specific amount of money, usually at least the amount of your payments. This happens even if your account has lost money and contains less than the guaranteed, set amount for the beneficiary.
Variable annuities are higher risk than fixed annuities and, consequently, have some drawbacks:
In addition to the principal of the annuity, variable annuities carry fees. In fact, the national average fee for a variable annuity is 3.61 percent, and it can even go over 5 percent. Some kinds of fees specific to variable annuities are:
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When you want out of your variable annuity contract, you have options. You could exchange your contract for a new annuity contract. This is allowed under Section 1035 of the U.S. tax code. This is helpful if you find another annuity with better features for your situation, such as more investment options. If you are still in the surrender charge period of your old annuity, you may be charged that fee, which can be as high as 9 percent. If you’re considering this exchange, you should be cautious and thorough about reviewing the contracts and whether you want to begin a new surrender charge period by starting in a new contract. The surrender charge period is typically from six to eight years, but can be as long as 12 years, depending on the contract. You should also consult with a tax professional or investment advisor to ensure that this exchange will indeed be tax free. To avoid taxes, the exchange can’t involve surrendering the old annuity for cash and then buying a new annuity with the money. Authorities warn that these exchanges may be bad for consumers, who may wind up losing money,
You could also sell all or part of your annuity to a company that specializes in buying annuities. This option should be explored before you try to cash in or change your annuity through your annuity provider. There’s a good chance that selling your annuity will get you a better return than other choices.
The accumulation phase of your variable annuity is the period during which you make payments that you direct toward particular investment options. These options should be explained in detail in the annuity company’s prospectus, which you should read and understand. For example, you could allocate a percentage to a bond fund, some to a domestic stock fund and the rest to an international stock fund. You might also choose to send some to a fixed account, which pays a set rate of interest, typically with a guaranteed minimum rate. During this phase, you usually can transfer money between accounts, but you may be charged a transfer fee. If you withdraw money during this phase, you may have to pay surrender charges and potentially a 10 percent federal tax penalty if you are under the age of 59 ½.
The payout phase is when you may receive your purchase payments, plus investment income, either as a lump sum or at regular intervals. If you receive the payments periodically, you can choose how long the payments will last. This can be for a set period of years or an indefinite period, such as your lifetime or the lifetime of you and a beneficiary, such as your spouse.