What you need to know about annuities

fixed annuities

traditional annuities earn a fixed rate of interest and pay a fixed income.

When you buy a fixed deferred annuity contract, you get two promises from the issuer: a fixed rate of return during the accumulation, or build-up period, while your retirement savings compound, and many ways to receive retirement income, including payments that are guaranteed to continue for as long as you live. The two promises are related. Your money in the annuity grows tax deferred until you’re ready to withdraw. The earnings rate paid on your savings, the amount you save, and the length of time your annuity grows all determine the income you’ll receive during the payout period. The insurer sets the initial rate, its term, and a guaranteed rate, which is the lowest that will be paid on the contract. After the initial term ends, the rate is adjusted on a regular schedule. There’s no way to be sure what the new, or current, rate will be, though the guaranteed rate remains fixed.

How Companies Invest

The amount you invest to buy a fixed annuity contract goes into the provider’s general account, along with premiums from other investors and other company revenues. Because the company has such large sums to invest , it can diversify its holdings and earn a better return on its investment than you could investing on your own, taking the same investment risk. A potential downside to buying a fixed annuity may occur if the issuing company gets into financial difficulties, since its creditors have a right to assets in the general account. These situations are relatively rare, however, since insurance companies are regulated and rated regularly, but they can happen. Be alert: Companies touring fixed annuity returns much higher than the rates offered by the competition may be too good to be true. Sometimes, promises of stellar returns are a red flag that annuity money is going into riskier investments, like junk bonds. Before buying, ask to see the rate that the issuing company hash paid over the past ten years and be sure to check the company’s ratings.

variable annuities

variable annuities offer investors more choices.

Variable annuities have many of the same features as fixed annuities—including tax-deferred earnings and a choice of payouts, plus the opportunity to make unlimited contributions if the annuity is nonqualified. In addition, they offer the potential for greater returns and the opportunity to make your own decisions about how to allocate your assets among investment funds offered through your contract. A potential downside of variable annuities, though, is that the return is not guaranteed. You may have only small gains—or no gains—in some periods and you could lose principal.

Creating A Portfolio

With variable annuities, lots of things can vary, or change: the rate of return you earn, the amount of income you receive if you annuitize, or convert your account value to a stream of income, and how your money is invested. When you buy a variable annuity, you allocate your premiums among a number of investment funds, also called subaccounts or annuity funds. The accounts may be designed specifically for the annuity company or may be versions of existing mutual funds that are customized for exclusive annuity use. Although the names of the investment funds may be the same or similar to those of retail mutual funds, they are not the same funds.

Your job is to choose among the funds that the issuing company offers, much as you would with a 401(k) or 403(b) retirement plan. Typically, there will be a dozen or more, including stock portfolios, a money market account, a government bond portfolio, a corporate bond portfolio, and a guaranteed account, which is similar to a fixed annuity investment. Sometimes you have an even wider choice drawn from a number of different investment management companies.