Annuities – Fixed and Indexed
Many people planning for retirement or looking to provide a guaranteed stream of income for themselves turn to annuities. But there’s a lot to know about these rather complex insurance products. Before putting retirement money or savings into an annuity, take time to know the key facts about the two main types of these structured insurance products.
What is a Fixed Annuity?
In the most basic terms, an annuity is sold by an insurance company and offers a fixed rate of return. The primary advantage and selling point is protection against the risk outliving longer than your money. No one wants to run out of financial resources, especially in old age. People want to have a safe form of retirement income. Contracts like these were created by life insurance companies to guarantee a fixed amount of income to those who own the contracts, who are called “annuitants.”
In much the same way that you insure your home or car, you use an annuity contract to insure your income. In exchange for this guaranteed income, you pay the insurance company a lump sum at the time the contract is signed. The vast majority of people who buy annuity contracts use savings or retirement money to make the initial payment to the insurance company.
A fixed annuity can pay you a fixed sum monthly or yearly, and there are endless ways you can set up the contract so that you can get your principal back if you decide you want out of the annuity contract. See the list of advantages and disadvantages below for the basic pros and cons.
The majority of people who purchase an annuity are looking for a way to defer income tax on retirement savings. Like a certificate of deposit (CD), a fixed annuity lets you delay payment of taxes until you start receiving payouts from the annuity. The principal is guaranteed and the interest earned is not taxed. What are the specific benefits of this type of account?
No investment arrangement is perfect. The typical annuity has its downside like everything else out there. Here are some of the most common disadvantages of purchasing one.
What is an Indexed Annuity?
An indexed annuity is a much more complex instrument than a fixed one. Subject to many variations about how payouts are administered and how, and whether, the principal is returned to an annuitant, the basic feature of an indexed annuity is a variable rate of return.
By tying the return to the general performance of the stock market, the annuitant receives higher returns on the investment when the market is doing well and lower returns when the market if off. Most contracts specify a capped interest rate, which means you won’t get stellar returns even when the market rises by a significant amount. Alternately, you are protected against a declining stock market with minimum rate guarantees.
Many insurance companies allow for multiple deposits, over time, into the account. This is in contrast to many types of annuities that are set up to receive just a single deposit of a lump sum.
One other feature that gets attention from investors is the “right to review.” It’s actually a free-trial type of setup that gives you between 10 and 30 days to decide whether you want to stay in the account or get your initial deposit back.
Key Things to Remember
The chief advantages of both fixed and indexed products include deferred tax liability, guaranteed rates of return and competitive interest rates compared to similar bank products.
It’s always important to thoroughly research the company issuing the contract and the structure of the contract before committing any amount of funds to an annuity account.
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