What is an Annuity?

Annuity Definition

Fixed Annuities

Equity Indexed Annuities

• Variable Annuities
• Immediate Annuities

Single Premium Immediate Annuities


Annuity Definition

An annuity is a contract between you and an insurance company in which the company promises to make periodic payments to you, starting immediately or at some future time. If the payments are delayed to the future, you have a deferred annuity. If the payments start immediately, you have an immediate annuity. You buy the annuity either with a single payment or a series of payments called premiums.

Annuities come in two types: fixed and variable. With a fixed annuity, the insurance company guarantees both the rate of return and the payout. As its name implies, a variable annuity's rate of return is not stable, but varies with the stock, bond, and money market funds that you choose as investment options. There is no guarantee that you will earn any return on your investment and there is a risk that you will lose money. Unlike fixed contracts, variable annuities are securities registered with the Securities and Exchange Commission (SEC).


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Fixed Annuities

Fixed annuities are invested primarily in government securities, and high-grade corporate bonds. They offer a guaranteed rate of return, typically over a period of one to ten years. There are two basic types of fixed annuities: the Guaranteed Return Annuities (GRA) is a fixed annuity that offers a guarantee that you can never receive less than 100% of your investment -- no penalties or fluctuations in the interest rate market can impact your principal should you surrender. The Market Value Adjustment annuity (MVA) works much like the GRA, but there is no guarantee of your principal if rates rise and you surrender your contract. MVAs work like a bond and often pay more than a GRA due to the increased short-term risk of rising rates.


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What is an Equity-Indexed Annuity?

Equity Indexed Annuities (EIAs) have characteristics of both fixed and variable annuities. Their return varies more than a fixed annuity, but not as much as a variable annuity. So EIAs give you more risk (but more potential return) than a fixed annuity but less risk (and less potential return) than a variable annuity.

EIAs offer a minimum guaranteed interest rate combined with an interest rate linked to a market index. Because of the guaranteed interest rate, EIAs have less market risk than variable annuities. EIAs also have the potential to earn returns better than traditional fixed annuities when the stock market is rising.


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Variable Annuities

Variable annuities enable you to invest in a selection of funds, called sub-accounts. These sub-accounts are tied to market performance, and often have a corresponding managed investment after which they are modeled, such as a mutual fund. Available choices range from the most conservative, such as money market, guaranteed fixed accounts, and government bond funds, to more aggressive such as growth, small cap, mid cap, large cap, capital appreciation, aggressive growth, and emerging markets funds. Some have as many as forty or more fund choices with ten or more managers, and allow you to switch between them at no cost and without taxes (although excessive changes to your contract could result in the imposition of a small fee, so be sure to consult your financial planner or prospectus if you are making regular changes).


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Immediate Annuities

With an immediate annuity, you begin to receive payments immediately upon investing your lump sum. This type of annuity is for investors that need immediate income. When you purchase an immediate annuity you have a few choices on how you receive your payments. You can choose a "period certain" (i.e. 5 to 20 years) or receive payments for the rest of your life and/or your spouse's life, or any combination of the two. You can even choose between a fixed payment that stays the same or variable payment that is based on market performance.


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Single Premium Immediate Annuities

Single Premium Immediate Annuities (SPIAs) are purchased with a single deposit amount. The funds that are used to purchase an immediate annuity could come from different sources, such as a Certificate of Deposit (CD) that is maturing; a Deferred annuity account; a profit sharing plan; a distribution from a tax-qualified defined benefit plan or an IRA account. The Single Premium Immediate Annuities (SPIAs) is also an excellent investment vehicle for the following:

1. Retirement from Employment
2. Terminal Funding or Pension Terminations (including deferred commencements)
3. Retired Life Buyouts
4. Structured Settlements for Personal Injury, Estate or Divorce cases
5. Professional Sports Contracts
6. Credit Enhancement and Loan Guarantee Transactions
7. Lottery Settlement

Once you have selected your payment method, (i.e. 5 yrs, 20 yrs or life) this annuity will usually start making regular monthly payments to you 30 days from the date you turn over the funds to the insurance company. In return for a sum of money, the insurance company promises to make regular payments to the owner or annuitant (if different) for a specific period of time, such as the remainder of the annuitant's life. By accepting the insurance company's guaranteed schedule of payments, you are usually giving up the right to demand the return of your original deposit and to change the selected payment schedule.

Good points to consider about an Immediate Annuity

1. Provides the investor with a lifetime income.
   
   
2. No longer a need to manage your investments, watch the markets gains or losses, or report interest or dividends to the IRS. The interest rates used by insurance companies to calculate immediate annuity income is generally higher than a CD or Treasury rate. Payments include the principal investment return and interest so your income is larger than an interest only payment.
   
   
3. Preferred Tax Treatment -- the immediate annuity enables you to postpone paying taxes on some of the earnings you have accrued in a "tax-deferred" annuity that has been rolled over into an immediate annuity (only the portion attributable to interest is taxable income, the bulk of the payments are nontaxable return of principal).
   
   
4. The investment is secure since the funds are guaranteed by the financial strength of the insurer and are not subjected to the fluctuations of the investment market.
   
   
5. There are no sales or administrative charges for an immediate annuity.

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