Annuity Types

An annuity is a financial product issued by an insurance company that converts a lump sum or series of payments into a guaranteed income stream, either for a set period or for life. Annuities come in several varieties, and understanding the differences is important because the features, costs, and risks vary significantly.

A fixed annuity provides a guaranteed interest rate on your investment for a specified period, similar in concept to a bank CD but issued by an insurance company. The principal is protected from market losses, and the interest rate is set at the outset. Fixed annuities appeal to those seeking predictability and safety, though the returns may be modest.

A variable annuity allows you to invest in a selection of sub-accounts (similar to mutual funds) within the annuity wrapper. The value of the annuity fluctuates based on the performance of the underlying investments. Variable annuities offer growth potential but also carry market risk. They tend to have higher fees than other annuity types, including mortality and expense charges, administrative fees, and sub-account management fees.

An indexed annuity (sometimes called a fixed indexed annuity) offers returns linked to the performance of a market index, such as the S&P 500, while providing a floor that protects against losses. The upside is typically capped or limited through a participation rate, spread, or cap rate. Indexed annuities sit between fixed and variable annuities on the risk spectrum.

Annuities can also be categorized by when payments begin. An immediate annuity starts making payments shortly after purchase, while a deferred annuity accumulates value over time before payments begin. A deferred income annuity (or longevity annuity) is purchased now but does not begin payments until a future date, often age 80 or 85, providing insurance against outliving your assets.

Annuities often include surrender charges for early withdrawals (typically during the first 5 to 10 years), and withdrawals before age 59 and a half may be subject to a 10% IRS penalty in addition to ordinary income tax on the earnings portion. Optional riders, such as guaranteed lifetime withdrawal benefits or death benefit enhancements, can add valuable features but also increase costs.