Types of Annuities
Annuities can be an important part of a financial plan, especially for those looking for safety, stability, and a guaranteed lifetime income. While there are many types of annuities, their one commonality is that, in one form or another, they guarantee some sort of income.
Annuities come in many shapes and sizes and with different features. Important things to understand include the following:
Although all annuities provide for some sort of income, for some annuities that is their only purpose.
- Income Annuities
- An income annuity’s sole purpose is to provide income. An insurance company guarantees payments to you in exchange for a premium. Typically income annuities have little or no liquidity (aside from the payments that you receive).
- Accumulation/Protection Annuities
- Accumulation annuities are used to accumulate (or protect already accumulated assets) assets in a safe manner. They also offer options for income, but the policyowner has a choice whether or not to elect to take income.
Annuities can begin their benefits immediately or after some period of time.
- Immediate Annuities
- An immediate annuity begins making payments shortly after the premium is received (typically within a year). An immediate income annuity is often referred to as a single premium immediate annuity (SPIA).
- Deferred Annuities
- Deferred annuities do not begin making payments until some time in the future. For accumulation annuities, it is up to the policyowner to elect income payments. Otherwise, the policyowner can let the funds continue to accumulate. There are also deferred income annuities (commonly referred to as a DIAs). They function similar to an immediate income annuity, except that the payments begin later in the future (e.g. ten years from when the policy is issued).
Another characteristic of annuities is how premium payments are structured.
- Single Premium
- Single premium annuities accept one premium payment. Income annuities are often single premium, and accumulation annuities can also be single premium.
- Flexible Premium
- Flexible premium annuities accept more than one premium payment. Most commonly these are accumulation annuities. The amount and timing of premium payments is at the discretion of the policyowner.
Annuities (aside from most income annuities, where interest earnings are behind the scenes) credit interest. The way in which interest is credited depends on the type of annuity.
- Fixed Interest
- A fixed annuity offers a guaranteed interest rate for a set period of time. For example, a fixed annuity could guarantee an interest rate for ten years.
- Indexed Interest
- An indexed annuity credits interest based on the performance of an index. These types of annuities allow for more upside (and still no downside) than traditional fixed annuities. They also have underlying guarantees, but are lower than a traditional fixed annuity.
There are two main ways to generate income from an annuity. For income annuities, annuitization is the only option. For accumulation annuities, either withdrawals or annuitization can be elected by the policyowner.
- Many annuity contracts guarantee an income that is based on a percentage of the account value at the time income begins. However, the policyowner still has the option to surrender the entire account.
- Under this option, a policyowners either have an income annuity or essentially convert their accumulation annuity’s account value into an income annuity. There are various ways that income can be paid out. The amount that gets paid depends on the age, gender, and type of payout that the annuitant(s) selects. Common options include:
- Life only or straight life annuity: payments are made to the annuitant for life, with no payments after the annuitant’s death.
- Period certain: payments are made for a specified period of time (e.g. 15 years). If the annuitant outlives the period, no further payments are made. If the annuitant dies before the period ends, the remainder of the payments go to a beneficiary.
- Life with period certain: payments are made for the life of the annuitant, but not less than the period certain. This ensures that income will last for the annuitant’s lifetime, but if the annuitant dies early on the beneficiaries still get something.
- Life with cash refund: payments are made for the life of the annuitant, and when the annuitant dies, if the cumulative payments made are less than the amount annuitized, the difference is paid in a lump sum to the beneficiary.
- Life with installment refund: payments are made for the life of the annuitant, and when the annuitant dies, if the cumulative payments made are less than the amount annuitized, the original payments continue until they equal the amount annuitized.
- Joint and survivor: payments are made when both annuitants are alive (such as a husband and wife) and also when only one is alive, for life. Other options include adding a period certain or specifying that if only one of the annuitants is living, the payment gets reduced (e.g. to one half or two thirds of the original payment).