Understanding annuity basics: Most people think of commercial annuities when they are discussing what an annuity is in general. Therefore, for the purposes of our discussion here, we will talk about commercial annuities. Which are offered to the public by insurance companies.
What is an Annuity? Understanding Annuity Terms & Definition
An annuity is a tax-deferred savings vehicle that credits account growth in various ways and pays out in various ways. The simple breakdown in annuities follows a binary path. When it comes to how they grow in value, annuities are typically either:
- fixed
- or variable
A fixed annuity typically does not go below the value of the cash invested. And earns interest usually through some kind of fixed mechanism.
A variable annuity (VA) contains options that allow the policy owner to invest in stock “funds,” bond “funds,” or other types of investments that involve market risk. Some VA’s offer a fixed option inside the contract too.
When it comes to how an annuity pays out, it breaks down to either:
- An immediate annuity
- Or a deferred annuity
Immediate annuity
An immediate annuity begins paying a monthly income in exchange for control of principal given to the insurance company. In other words, hypothetically, you give the insurance company $100,000, and they give you $750/month for the rest of your life. It’s like taking a pension (under generic financial definitions, a pension is an “annuity”).
Deferred annuity
A deferred annuity grows tax deferred and earns interest either through some kind of fixed mechanism or a variable (market) mechanism as mentioned above.
So in summary, you can have:
- a deferred fixed annuity
- a deferred variable annuity
- an immediate fixed annuity
- an immediate variable annuity
Fixed Index Annuity
There are other subsets of annuities that we will not explore too deeply here. For example, a Fixed Index Annuity (FIA) is a fixed annuity. But an FIA earns interest through some quasi market mechanism.
However, unlike variable annuities, these will not lose value and tend to lock in any gains yearly. These programs vary so much from company to company that an analysis here would be tiresome (call me if you want the run down: 888-278-9433 x5).
The Purpose of an Annuity
Annuities are meant to, and motivated by the tax code to supplement retirement income. Some rules of thumb are that if you max out your 401k and an IRA, then an annuity can supplement. However, today’s higher limits on retirement plan contributions make this motivation to use annuities remote (very few people can put $18,000 into their retirement plan, then another $5,500 into an IRA on a yearly basis).
Therefore, annuity companies had to come up with other reasons and new purposes to own these things. In the past 10-15 years, we have seen annuity companies issue various riders and benefits on policies. Offering such things as guaranteed income, guaranteed withdrawal, lifetime income, and principal protection.* Whether or not any of these options would be of benefit to you is a case by case analysis.
Don’t Know What to Do?
If you have an existing annuity and want to consider annuity rollover options, also known as 1035 exchanges, check out our 1035 exchange page HERE.
Are you curious if working with me and my team would be mutually beneficial? Then Contact us here to fill out some initial questions and we will follow up with you.
Warmly,
Chris Grande
Notes:
*Guarantees offered by insurance companies are based on the claims-paying ability of the insurers and are not government or FDIC guaranteed in any way
See our disclaimer HERE
