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Understanding the 4 types of annuities for specific investment needs

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Annuities aren’t a one-size-fits-all product. People buy annuities for different reasons, and their choice of annuity type varies according to their goals and needs.

Insurers have an array of annuity types to offer their clients. In a blog, Truth About Annuities, investment expert Suze Orman explains that different types of people, or people in different life situations buy different types of annuities. Here are some descriptions of those annuity types—and some information about the people who purchase them.

Single premium deferred annuity

Individuals purchase a single premium deferred annuity (SPDA) by depositing a single premium into the policy. Taxes on that payment are deferred until the individual begins to withdraw money in the form of payouts. This type of annuity guarantees a specific interest rate for a specific period of time, which can vary from one to several years, like a bank CD.

As with all annuities, the overarching goal for SPDA buyers is to invest money that will generate income. Individuals most likely to buy an SPDA, according to Orman, are those who want to allow their money to grow risk-free while avoiding paying income taxes on that money.

Single premium immediate annuity

Similar to the SPDA, the single premium immediate annuity (SPIA) requires an individual to invest one lump sum to purchase this product. Immediate annuities guarantee that individuals receive a fixed income for the remainder of their lives, and the payouts begin immediately. The amount of the income varies and is based on the individual’s age, current interest rates and the maximum period the individual has opted for payouts. There are tax benefits as well.

There are several advantages to an SPIA. First, an SPIA is appropriate for those seeking a guaranteed monthly income that comes with tax benefits. An SPIA works for those who don’t have beneficiaries when they pass away, and for those who are looking to boost their income rather than making a typical interest-bearing investment. Orman explains that those who buy this type of annuity are also looking to leverage a high interest-rate environment. “The perfect time to have purchased an immediate annuity, for example, with respect to interest rates, would have been in the eighties, when interest rates were high, not in the late nineties, when interest rates are relatively low,” she points out.

Variable annuity 

A variable annuity is a contract between an individual and insurer for a specific period of time, but money deposited into this type of annuity is typically used to buy different mutual funds. Individuals can choose from a variety of funds to invest their money. Variable annuities also provide tax benefits, so individuals will not have to pay taxes on the gains until they withdraw funds. And, according to Orman, there’s no risk of losing your shirt. “Even if you invested 100% of your money in a risky mutual fund within the variable annuity, you are guaranteed that in the end you will never get back less than what you originally deposited or whatever the current value of the account is, whichever is more. In a regular mutual fund not held within a variable annuity, there is no such guarantee,” she points out.

Variable annuities are often purchase by those with no beneficiaries, those who like to buy and sell mutual funds, and those in a very high tax bracket but who anticipate a lower tax bracket upon retirement.  

Index annuity 

Index annuities track an index like the Standard and Poor’s 500 Index. Individuals who purchase index annuities receive a return on their money that’s typically a percentage of how that index performed during each investment year. If the index annuity tracks the S&P 500 index and it goes up, the individual receives a set percentage of the annual return of the index from the day of initial deposit for a period of one year. This type of annuity enables the individual to avoid any downside risk at all while enjoying a percentage of the upside gains—so while it doesn’t pay the full amount of a mutual fund that buys the entire index, it eliminates any possibility of losing the initial outlay.

An index annuity is a great choice for those willing to forfeit upside potential while protecting completely from any downside risk, so it works for those who like to invest in the market but don’t want to lose money.

Agents who truly understand not only the different annuity types, but who also understand their customers’ retirement and income goals and needs—as well as their tax situation and appetite for risk—can do an extraordinary job in matching suitable products to individuals. 

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