Overview of Annuity Types

In general, an annuity is a contract in which an investor pays a premium or a series of premiums, and in return the insurer makes a series of income payments. Normally, annuities are purchased to secure future retirement income for individuals.

There are three basic annuity types: fixed, variable, and indexed. A particular company may be calling their annuities something slightly different. However, all annuities can be classified into these three types.

Fixed Annuity

Fixed annuities earn interest at a set rate during the accumulation period of the annuity. During the payout period, again, the income payments are made to the investor at a fixed rate. Some investors are confused by the term fixed. The term fixed means that the contract is fixed, but does not mean that the rate cannot change. It only means that the way in which it can change or be reevaluated is clearly spelled out in the initial annuity contract.

Variable Annuity

The second annuity type is a variable annuity. With a variable annuity, the investor's premiums are entered into a separate account. The investor then chooses how the premiums are invested. The majority of variable annuities are setup to invest in mutual funds. However, accounts also exist for stock and bond investments. During the payout period, income payments made to the investor vary in relation to the performance of the separate investment account.

Indexed Annuity

The final annuity type is an indexed annuity. An indexed annuity earns interested based on an external financial index, such as the S&P 500. Interest that is credited to the annuity is based on a formula that is linked to the underlying index. An indexed annuity also is usually guaranteed to pay a minimum interest rate so that investors do no lose their initial investment premiums.

Payout Structures: Immediate and Deferred

Two different types of payout structures exist with annuities - immediate and deferred. An immediate annuity usually has income payments that start no later than one year after the premium is paid. Usually, the premium payment is in one installment. Immediate annuities offer a way for older Americans to have a guaranteed income for life that they can access in the short-term.

The opposite is true for deferred annuities. Income payments often start many years after the premiums are paid. Deferred annuities have the advantage that earnings are automatically re-invested over the accumulation period. Investors that have more time before their retirement can take advantage of these automatic re-investments of earnings. Earnings can also be withdrawn early with deferred annuities, usually up to a certain amount.

In summary, there are three basic annuity types: fixed, variable, and indexed. Each type has its own advantages and disadvantages and appeals to different types of investors. Once the general type of annuity is selected, investors can also chose between immediate and deferred payout structures. As the names suggest, immediate payout structures start quicker than deferred payout structures. However, deferred payout structures offer the advantage that annuity earnings are automatically re-invested during the accumulation period.

For more information from Steven on how to invest in annuities and common investment mistakes, visit his Immediate Annuity Guide. To learn more about securing your retirement with life annuities, visit the Life Annuity Guide.

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