An annuity is a long-term savings product that can be used to accumulate assets on a tax-deferred basis and obtain a stream of retirement income. There are many different types of annuities, but most share a basic structure: you purchase the annuity—either through premiums or a lump sum payment—and then at some point in the future, benefits are triggered, providing a regular source of income.
Individuals face four key challenges in retirement—longer life expectancies, taxes, inflation, and market volatility. Annuities can work to combat all four of these factors. By growing tax-deferred, certain annuities are able to grow larger before facing a tax liability. This, along with interest rate of growth, helps to hedge against inflation. Because many annuities have guaranteed rates of return and are not directly exposure to the stock market, they are less susceptible to market volatility. Finally, with a lifetime income rider, consumers can obtain a source of income that cannot be outlived.
Phases of an Annuity
Most annuities have two phases—an accumulation phase and distribution phase. During the accumulation phase, premium payments are collected and cash value within the contract account grows at a pre-determined rate.
Upon a triggering event—in most cases retirement—the annuity then begins to issue benefit payments from the account. With a lifetime income rider, it is possible to receive benefit payments for the remainder of an individual’s life.
Just as you would find in the life insurance world, there many different types of annuities, all designed to meet different needs. Additionally, the specifics of an annuity will vary amongst the carriers and contact type.
Types of Annuities
Just as you would find in the life insurance world, there many different types of annuities, all designed to meet different needs. Additionally, the specifics of an annuity will vary amongst the carriers and contact type. While there are numerous versions of annuities, there are a few basic categories.
Fixed (FA), Fixed Indexed (FIA), Single Premium Immediate (SPIA, and Deferred Income (DIA).
A Fixed Annuity, sometimes referred to a as a traditional fixed annuity, provides a guaranteed interest rate as well as an initial interest rate. The actual interest rate may vary over the life of annuity, but will not fall below the guaranteed minimum interest rate (GMIR). No matter stock market performance or the overall interest rate environment, the contract will continue to grow at the declared rate.
Fixed Indexed Annuity
A Fixed Indexed Annuity (FIA), sometimes known as an equity indexed annuity, provides growth based on the performance of a specific stock market index, such as the Standard and Poors 500. Most FIAs involve a floor or guaranteed minimum interest rate that secures a base return. There are several ways in which the interest can be credited to the contract, and in general there will be a predetermined cap that positive growth can reach. However, if the specified index sees a negative performance, the accumulated value is protected and will not be subject to a negative interest rate. It is important to remember that although Fixed Indexed Annuities have a tie to a stock market index, there is not direct participation, and no market exposure.
Single Premium Immediate Annuities do not involve a significant growth or deferral period. Rather they are structured to provide benefits immediately, as the name suggests. Purchased with a lump sum, the benefit payment amounts you receive will depend on the amount of annuity you purchase, your life expectancy when you buy the product, your gender, and the interest rate environment. With a fixed income payment option (Single Premium Immediate Fixed Annuity, or SPIFA) your benefit amounts are distributed in regular amounts with predictable frequency.
Deferred Income Annuities
Deferred Income Annuities are very similar to Single Premium Immediate Annuities, in that they are purchased with a lump sum. But unlike SPIAs, Deferred Income Annuities can be deferred for a set period of time. It may also be possible, depending on the contract, to contribute over the initial purchase amount. This type of annuity is often referred to as longevity insurance because DIA’s provide lifetime income built into the contract.
Who are Annuities for?
Whether or not an annuity will be a fit for you will depend on your specific goals and financial objectives. But if you are seeking a product that can provide you guaranteed income during retirement then an annuity may be for you. If you desire steady growth and a predicable benefit payout, you may want to consider a fixed annuity. If you want more upside potential, then you may want to explore fixed indexed annuities. If you are seeking to retire soon and don’t have time for a deferral period, consider a Single Premium Immediate Annuity.
Keep in mind that this overview of annuities is a simplification designed to help you orient yourself within the world these financial products. There are multiple factors that determine what will help you achieve your financial objectives.
Furthermore, these products get more detailed the more you drill down to specifics. Keith Collins, Inc. is here to help you develop your ideal financial plan and find the best solutions to secure a robust retirement.