Types of Annuities
There are five main types of annuities: Fixed, variable, deferred, immediate and indexed. Each plays a unique role in when you receive payments in retirement and the payout amounts. Other categories, such as life and period certain, describe how long payouts last.
What Are the Main Types of Annuities?
The type of annuity you buy determines your future annuity payments.
Fixed and variable refers to the size of payments you receive from the annuity company.
Annuities may also be immediate or deferred. This refers to when the insurer begins paying you money.
- Money in the account grows tax-deferred until you withdraw it.
- The annuity establishes a contract between you and an insurance company.
- Annuities provide periodic payments for a designated time.
- Fixed
- A minimum rate of interest is guaranteed, and periodic payment amounts do not fluctuate.
- Variable
- Includes a separate account where money is typically invested in mutual funds. Value varies depending on the performance of these underlying investments. Variable annuities carry the greatest risk.
- Deferred
- Annuity payouts are delayed until a future date. This gives money in the account time to grow during a process known as the accumulation phase.
- Immediate
- Payouts begin shortly after you make a lump-sum payment to the insurance company.
- Indexed
- Earns interest based on a market index, such as the S&P 500. Greater potential for gains than fixed annuities but with less risk than variable.
Key Differences in Annuity Types
Exploring key differences side by side is one of the easiest ways to determine the best annuity type for you.
| Annuity Type | Pros | Cons | Fees |
|---|---|---|---|
| Fixed | Simple and straightforward. Based on a fixed rate of return. | Lower payouts than other annuity options. | None. However, there are usually surrender charges. |
| Variable | Potential for greater returns than other options. | Carries the most risk. You may lose your principal. | Highest. |
| Immediate | Payments begin within a year after purchasing it. | You can no longer access the principal once payouts begin. | None. |
| Deferred | You don’t pay taxes during the accumulation phase. | Payments are delayed. | Some. |
How Long Will Payouts Last?
You can customize many aspects of your annuity contract, including how long you want to receive periodic payments.
Annuity payouts can last the rest of your life or only a certain amount of time.
Some annuities also allow you to leave remaining funds to a beneficiary upon your death. Others turn your remaining balance over to the insurance company instead.
- Single Life/Life Only
- Payments for life but no survivor benefit.
- Life Annuity with Period Certain
- Guarantees payments for life while also ensuring a beneficiary receives the rest of your annuity payments if you pass away during a certain time.
- Joint and Survivor Annuity
- Payments last the lifetime of you and a survivor — usually a spouse.
Using Annuities for Retirement Income
A growing concern for many older Americans is outliving their savings during retirement. In 2020, the average cost of retirement was $987,000, according to 24/7 Wall Street.
Annuities act as insurance against this risk. They provide a reliable stream of income tailored to meet your needs.
Immediate fixed annuities and variable annuities are two popular options to safeguard retirement income.
Immediate fixed annuities are the most common type of annuity. They share many similarities with pensions.
To purchase one, you pay an insurance company a lump sum of money. In return, the insurer guarantees to pay you a fixed monthly payment.
If there’s still money left in the annuity when you die, it goes back to the insurance company.
Variable annuities allow you to retain control over your principal. However, the size of your regular payout depends on the performance of underlying investments.
To protect against market instability, many insurance companies offer additional riders at an extra cost.
A guaranteed lifetime withdrawal benefit rider, for example, allows you to take money out of a variable annuity at a certain minimum level, regardless of market performance.
Tips for Growing Retirement Income
An annuity can be a smart addition to your retirement plan. These insurance products should not substitute a well-balanced investment portfolio.
Annuities can be complex, and contract details may be difficult to navigate. It’s best to speak with a trusted financial advisor to identify the best retirement income vehicle for you.
It’s also important to consider other investment options that help diversify your portfolio. Maxing out your 401(k) or IRA contributions is a good place to start.
Fixed securities, such as bonds and certificates of deposit, are other popular savings vehicles for retirement. These investments guarantee a fixed rate of return with minimal risk.
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