What Are 5 Types of Annuities?

In my opinion, annuities are among the most confusing investments. The seemingly endless options, features, and benefits can discourage you from investing in them to help reach your retirement goals or leave an inheritance for your loved ones.

Fortunately, when I worked as a licensed financial coach, I had a team, tools, and technology helping educate me on how annuities work and how they can help individuals and families reach their goals. I learned to explain the benefits, features, and costs to explain why a certain annuity made sense for a specific situation.

The following details help demystify the five main types of annuities. I recommend talking with a licensed financial professional for additional information.  

What an Annuity Is

An annuity is a contract between you and an insurance company. You submit one premium or a series of premiums, and the company agrees to the terms detailed in the contract:

• You can choose to receive distributions on a monthly, quarterly, semiannual, or annual basis.

• Alternatively, you can let the funds grow tax-deferred or leave the lump sum to a beneficiary.

• The annuity might have a death benefit that provides any remaining payments to a beneficiary.

• Optional riders, such as an enhanced death benefit or long-term care, might be available for additional fees.

Five Main Types of Annuities

The five main types of annuities include:

1.     Immediate annuities

2.     Deferred annuities

3.     Fixed annuities

4.     Variable annuities

5.     Indexed annuities  

Immediate Annuities

An immediate annuity offers a stream of income right away:

• You give a lump sum of money to an insurance company and receive payments based on the contract terms.

• You receive guaranteed payments that can be structured for a certain time, such as 10 or 20 years, or the rest of your life.

• If you pass away prematurely, any remaining payments could be distributed to your spouse or beneficiary.  

An immediate annuity offers the highest payments of any annuity and can help address immediate income needs. However, these annuities have significant drawbacks:

• Because an immediate annuity cannot be surrendered, you have less access to the funds than with other types of annuities.

• The fixed payments might not be adequate to keep up with inflation.

• Not all immediate annuities include a refund option to pay any remaining balance to a beneficiary if you pass away prematurely.

Deferred Annuities

A deferred annuity provides regular income payments later in life, typically during retirement:

• A deferred annuity has an accumulation phase, where the funds grow, and a payout phase, where the funds provide regular income.

• During the accumulation phase, you contribute funds for the insurer to invest.

• The funds accumulate interest and grow tax-deferred.

• The payout phase begins when you decide to start receiving income.

• You can receive a steady stream of income for the rest of your life, and potentially for the rest of your spouse’s life.

• Withdrawals are taxable.

• Withdrawals before age 59 ½ are subject to a 10% tax penalty.

• You might pay surrender fees if you make early withdrawals or cancel the contract.

Fixed Annuities

A fixed annuity guarantees the principal throughout the life of the contract and offers a guaranteed rate of return for a specific number of years:

• A fixed annuity has a guaranteed interest rate for a certain time.

• Compound interest increases the value of the annuity.

• Withdrawals are taxable.

Although a fixed annuity provides a regular rate of return, there are significant drawbacks:

• The interest rate might not keep pace with inflation.

• You are committed to the interest rate regardless of economic fluctuations.

• Surrender charges apply if you terminate the contract within a specific period.

• A 10% early-withdrawal penalty applies if you withdraw funds before age 59 ½.

Variable Annuities

Variable annuities are designed to create a stream of guaranteed payments for life during retirement:

• Your money is allocated to investment options called subaccounts.

• You receive the interest credited from the subaccounts.

• Because the subaccounts are linked to the market, a variable annuity can yield greater appreciation of earnings than a fixed annuity.

• Payouts can be structured as systematic withdrawals.

• Depending on the performance of the subaccounts, you could receive a higher payout than with a fixed annuity.

• Earnings are tax-deferred.

Like any investment, a variable annuity has drawbacks:

• Fees for a variable annuity include mortality and expense, administrative, subaccount, and annual service charges.

• Since the subaccounts are linked to the market, the money you contributed could be lost.

• Surrender charges apply if you terminate the contract within a specific period.

• A 10% early-withdrawal penalty applies if you withdraw funds before age 59 ½.

Fixed Indexed Annuities

A fixed indexed annuity credits interest based on the performance of a specific stock market index. Common examples include:

1.  S&P 500: The S&P 500 is Standard and Poor's stock market index that tracks the stock performance of 500 leading companies listed on stock exchanges.

2.  Dow Jones Industrial Average: The Dow Jones Industrial Average is a stock market index of 30 prominent companies listed on stock exchanges in the United States.

3.  NASDAQ: The National Association of Securities Dealers Automated Quotations is a global electronic marketplace where investors buy and sell stocks and other securities.  

 A fixed indexed annuity has the following features:

• You participate in positive changes within an index to a limited degree.

• Interest rates are based on positive changes in the index.

• The minimum credit typically is 0% because the principal is not directly exposed to the market.

• Many fixed annuities pay a minimum guaranteed interest rate regardless of how the index performs.

• Payouts can be structured as guaranteed periodic payments.

• The annuity might have fees and expenses, but it cannot lose value due to declines in the index.

The drawbacks of a fixed indexed annuity include:

• You might not receive all of the potential stock market index returns.

• Because the interest depends on the contract terms and the index to which the annuity is tied, you might make more money in other investments.

• Surrender charges and early-withdrawal fees might apply.

 *This information is for educational purposes only.