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What are the different types of annuities?
The large number of annuity products on the market today can make understanding them difficult. But in fact, there are only a handful of different types of annuities, and we will help you find the best types to suit your needs. First, let’s discuss the three primary considerations when thinking about annuities:
Timing of payout — immediate or deferred:
The first thing to determine is if you need an immediate or deferred annuity. Read on to learn the difference.
In an immediate annuity, the investor begins to receive payments immediately upon investing. This is for investors that need immediate income from their annuity. When you purchase an immediate annuity you can choose between payments for a certain period of time (typically five to twenty years - “period certain”), 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 doesn’t vary or a variable payment that is based on market performance.
In a deferred annuity, you typically receive payments starting at some future date, usually at retirement. However, most deferred annuities allow for systematic withdrawal payments beginning thirty days after the purchase of your annuity, up to 10% per year, in most cases. With a deferred annuity you can invest either a lump sum all at once, or make periodic payments, either fixed or variable. Those funds grow tax-deferred until you’re ready to begin receiving payments. Deferred annuities make up a large majority of all annuity sales in the United States, and are the type of annuity that Annuity FYI generally recommends if you do not need immediate income from your annuity.
Investment type — fixed or variable:
The next decision to make is the investment type best suited to your needs: fixed or variable.
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 fifteen 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. It is important to note that, unlike a variable annuity, where your funds are held separately from the insurance company, with a fixed annuity your assets are part of the general accounts of the insurer, and are subject to the claims-paying ability of the issuing company. For this reason it is important to understand the financial strength of the issuing insurance company before you buy a fixed annuity. See our section on financial strength ratings for more information.
Variable annuities enable you to invest in a selection of portfolios, called sub-accounts. These sub-accounts are tied to market performance, and often have a corresponding managed investment after which they are modeled. 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 investments. Some have as many as forty or more investment 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).
One special type of variable annuity is the living benefit annuity, also known as a GRIB (Guaranteed Retirement Income Benefit). The most competitive living benefit annuities guarantee at least a 5% return over seven years, or the highest attained value on each anniversary during the surrender period, whichever is greater. In exchange for this living guarantee, the living benefit annuity has a surrender charge, or penalty for early withdrawal, no up-front bonus, and a slightly higher annual fee. Guaranteed ifetime withdrawal benefit annuities are also very popular. The concept behind a Lifetime Withdrawal Benefit is simple. If you purchase a Lifetime Withdrawal Benefit Rider with your variable annuity, the insurance company guarantees a regular monthly, quarterly, or annual payment for your lifetime, even if your account balance goes to zero.
Finally, you will need to determine which liquidity option best suits your needs: those with or without withdrawal penalties.
Annuities with Withdrawal Penalties
“No-surrender” annuities allow you to withdraw either your interest earnings or up to 15% per year without a penalty (although any withdrawal from an annuity may be subject to taxes and a 10% federal penalty if taken prior to 59? years of age). Beyond that, most annuities have a surrender charge — a penalty for making an early withdrawal above the free withdrawal amount. Typically this surrender charge decreases over a seven-year period.
Why would you choose an annuity with a withdrawal penalty? Well, some annuities with surrender charges reward the investor by offering a “bonus”: the insurance company adds on average 3% to 5% to the amount of your principal. For example, if you invest $10,000 in a bonus annuity the insurance company will add $300 to $500 to you annuity immediately. The trade-off is that with a bonus annuity the surrender period is usually longer (eight to nine years in most cases versus the typical seven-year surrender). Be aware, some insurance companies charge higher fees on their bonus annuities, as compared with their standard products. Be certain to compare the annual fees of a bonus annuity to the standard or traditional (no-bonus with 7 years of surrender) annuity. Sometimes the life insurance company will raise their fees to pay for the bonus.
Annuities without Withdrawal Penalties
For investors who may need spur-the-moment access to their money, there are annuities without surrender charges (no-surrender or level load annuities) — these annuities have no penalty or charge for early withdrawal. (That said, even with a no-surrender annuity investors under the age of 59 ? are subject to a 10% federal excise tax as well as ordinary income taxes on any gains. You can avoid any taxes or penalties, however, by making a 1035 Tax-Free Exchange to another annuity, regardless of age.) No-surrender annuities do not come with bonuses, and some insurance companies charge higher fees for their no-surrender charge products, so be sure to compare all fees before you invest.
Most companies now offer no-surrender annuities. However, if you are asking a local broker or agent for their recommendation they may not share with you the no-surrender annuity, as these annuities pay the broker a much lower fee. Some agents will even try to steer the investor to annuities with surrender charges but without bonuses.