The basics of annuities are the same no matter what type you purchase: You pay an insurance company a set amount of money in return for regular payments, a guaranteed income that can help fund your retirement.
But when these payments arrive, how long they continue, and how big they are all depend on the type of annuity and the specific terms you agree to.
Here are a few of the most common types of annuities and how they might fit into your own retirement planning.
Fixed vs. variable annuities
These are the main annuity categories, and the first you’ll need to choose between. If you were walking down a wooded path toward a happy and well-funded retirement, this is the first place the trail would split.
The difference is pretty simple: Fixed annuity payments are, well, fixed: You’ll receive equal dollar amounts every time you get a paycheck. You agree on a fixed interest rate at the time of your investment, and you receive payouts based on that figure.
For example, if you purchased a fixed annuity with a 4% interest rate and a 10-year payout period for $500,000, then you’d get a $5,045 check each month for 10 years. The interest you’d earn over time would total $105,433.70 — and you’d know all of this ahead of time.
Variable annuities’ payouts, on the other hand, fluctuate with market performance. Just as you do with your 401(k), IRA, or other retirement profile, you allocate your variable annuity investment into a set of stocks and/or bonds, and your payouts reflect the success or failure of the market.
If you can’t decide between a fixed or variable annuity, an equity-indexed annuity might be the one for you. Equity-indexed annuities combine the best of both worlds by offering both the security and simplicity of a guaranteed return with a chance to earn more if the market performs well. (If the market falls, you’ll still receive the agreed-upon minimum repayment.)
However, some equity-indexed annuities come with caps on both your potential returns and your “participation rate,” i.e., the percentage of the benchmark index’s returns that will apply to your funds. These caps can seriously limit your investment’s growth. Read the fine print carefully, as these caps may change over time — which, coupled with inflation, could severely hinder your annuity’s performance.
Deferred vs. immediate annuities
Now that we’ve talked about how much money you’ll receive in your annuity payments and why, let’s talk about when you’ll actually get them.
An immediate annuity — surprise, surprise — starts paying returns immediately after it’s funded.
A deferred annuity is one you open well ahead of the time you wish to start receiving payments — think 10, 20, or 30 years down the line.
The benefit of a deferred annuity is that your investment has more time to grow, which means you could see higher returns during the repayment period. But immediate annuities are a great option for investors who are already, or will very soon be, retired.
Fixed-period vs. lifetime annuities
A fixed-period annuity, also sometimes called a period-certain annuity, guarantees your payments over a specific period of time — which means if you die before the period is over, the rest of the payments will go to a beneficiary.
A lifetime annuity, on the other hand, guarantees payment during the investor’s lifetime only, with no benefits for the loved ones who survive you.
There are also annuities that offer income for life with additional riders to pay beneficiaries within a set period, as well as joint annuities, which grant payouts to your spouse for the remainder of his or her life after you die. Of course, each of these additional features comes at an additional cost, which eats into the annuity’s total returns.
Which type of annuity is right for you?
Every personal finance choice is just that: personal. The only people who really know which type of annuity — if any — is right for you and your family are, well, you and your family. (And maybe your financial advisor.)
But all these different types offer a variety of features that can help you customize your annuity to your needs, family situation, and risk tolerance. For example, if you have lots of time left before you retire and don’t want to play dice with your eventual income, a fixed, deferred annuity could be right for you. If you’re already retired and have a large lump sum ready to go, you might look into an immediate lifetime annuity.
On the other hand, if you’re looking to maximize your total financial gains and avoid administrative fees, the relatively high costs and low margins of annuities might discourage you from buying one.
No matter which options you choose, or even if you forgo an annuity altogether, having a solid retirement plan in place is one of the most critical steps you can take toward financial wellness.