Annuities can be an essential component of a comprehensive retirement plan. However, they are often misunderstood leaving some with more questions than answers. The goal of annuities is to be used as a safety net to help provide a guarantee of some sort and are commonly used to provide a guaranteed stream of income. Annuities were developed with the sole purpose of mitigating the concern that income will not be guaranteed in retirement. With the cost of living and national life expectancy rising, it is expected that many of us will live longer than we thought – or worse, than we have financially prepared for, which is why annuities can be so important in a comprehensive retirement plan.

There are several types of annuities available, including: fixed, variable, fixed indexed, immediate, and deferred annuities. Here are some answers to some of the questions frequently asked.

A fixed annuity is a fixed investment issued by an insurer that pays guaranteed rates of interest, which are typically higher than what bank CDs offer. A major benefit of a fixed annuity is that you can defer income or draw income immediately. Fixed annuities are most popular amongst the retirement and pre-retirement communities, as it offers the owners no-cost, modest, and guaranteed fixed investment.

Variable annuities offer the owner the ability to choose from a plethora of sub-accounts known as mutual funds. The value of the account is determined by the performance of the mutual funds. A rider can be purchased for variable annuities, which means that the owner can lock in a guaranteed income stream regardless of the market performance. Riders are used as a method of hedging in the event that sub-accounts perform poorly. Once again, this type of annuity is most popular with retirees and pre-retirees who are seeking a shot at capital appreciation in conjunction with guaranteed lifetime income.
A fixed indexed annuity is essentially a fixed annuity with a variable rate of interest that is added to your contract value if an underlying market index – such as the S&P 500 – is positive. Fixed indexed annuity commonly offers a guaranteed minimum income benefit, and the chance of principal upside attached to a market-based index. One significant drawback is that upside potential is limited by a so-called participation rate, caps or a spread – all of which are methods that trim your return when in a rising stock market. As a consequence of trimming, buyers of fixed indexed annuities are never able to keep pace with a flourishing market. This type of annuity commonly appeals to retirees who want to conservatively participate in market appreciation without the potential of downside to their principal due to stock market index losses.
In lieu of regular premium payments (which will in turn be paid as a lump sum following death) the investor gives the insurer a lump sum in return for regular income payments until death occurs, or for a specified period of time which typically begins 12 months after receipt of the investment. Payments for immediate annuities are traditionally higher than other annuities due to the fact that they include principal as well as interest, and also may offer favorable taxation treatments. These are most popular amongst the retiree/pre-retiree community who need a higher-than-average source of income and are comfortable with sacrificing principal in exchange for higher lifelong income.

A deferred annuity delays payments until a future date which must be greater than 12 months. These enable individuals to increase their income source later in life for less money because the insurer is not committed for as long when the income payments are deferred. This type of annuity mostly appeals to people who want guaranteed income in the future, or for those who want to create a ladder of income over different periods later in life. For example, many will want to work during retirement and will not need the annuity until after they have completely stopped working.