Types of Annuities: 9 Questions Answered

Here's what investors should know about annuity contracts, including when income begins for each type.

What is an annuity/?

Strictly speaking, the term “annuity” refers to a series of payments over time in which the principal (or purchase price) and interest are amortized over the payout period, so that no value remains at the end of the annuity period; it is a stream of income.

However, most people who use the term “annuity” are referring to an annuity contract, under which that stream of income is guaranteed. There are several types of annuity contracts.

1. What are the types of annuity contracts?

There are several types of annuity contracts: (1) commercial annuities, which are contracts between a purchaser and an insurance company, (2) charitable gift annuities and (3) private annuities. When people talk about “annuities,” they are referring to commercial annuities. There are many types of commercial annuities, and they are very different because they are designed to do very different jobs.

2. When do annuity payments begin?

It depends on whether the annuity is fixed or deferred:

3. How is the contract value invested/?

It depends on whether the annuity is fixed or variable:

4. What is a fixed annuity/?

A fixed annuity is an annuity contract in which the value is reckoned in fixed units (in the U.S., U.S. dollars). There are three classes of fixed annuities: (1) fixed immediate annuities, (2) fixed deferred annuities and (3) fixed deferred income (“longevity”) annuities.

5. What is a fixed immediate annuity?

A fixed immediate annuity is one that pays a defined amount of income each period (which ma be level or increasing in accordance with a “cost of living” provision), commencing no later than one year after purchase, and persisting for a defined period (which may be the lifetime(s) of the annuitant(s)).

6. What is a fixed deferred annuity/?

A fixed deferred annuity is one providing for the payment of an annuity income at some later time (perhaps many years after purchase); during the accumulation period (from purchase to the annuity starting date (ASD), the contract will earn interest.

7. What is a fixed deferred income annuity/?

The third basic class of fixed annuities is the fixed deferred income, or “longevity” annuity. This is a contract guaranteeing a certain amount of income for a specified period (or lifetime(s)) to commence at some specified later age, usually an advanced age. During the accumulation period, there is no interest crediting and the contract may terminate without value if the annuitant dies before the Annuity Starting Date (ASD), although some contracts provide for a pre-ASD death benefit.

8. What is a variable annuity/?

There are two types of variable annuities: (1) variable immediate annuities and (2) variable deferred annuities. For both types, the value of the contract (the cash value of the deferred contract or the size of the income payment of the immediate contract) varies with the performance of the “separate accounts” chosen.

Unlike fixed deferred annuities, variable deferred annuities do not guarantee either a minimum rate of interest or safety of principal. Indeed, the concept of “interest” can be misleading when applied to a variable deferred annuity, as the value of the contract does not vary by the addition of interest, but in the fluctuating value of the “accumulation units” purchased in the “separate accounts.”

9. What are the ‘separate accounts’ in a variable annuity/?

The “separate accounts” in a variable immediate or deferred annuity are investment accounts, similar in some respects to mutual funds, with specified investment objectives. The contract owner purchases these accounts in “accumulation units” (for deferred variable annuity contracts) or “annuity units” (for immediate variable annuities). The cash value of the deferred annuity and the amount of each annuity payment in the immediate annuity will vary according to the performance of these units, which are re-priced daily.

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