There are several kinds of annuities, but all have the same basic structure: you purchase the contract—either through regular premiums or a lump sum—and then at a point in the future, benefit payments are triggered.
For some individuals, annuities can be a helpful resource to obtain regular income during retirement. Some annuities include a cash value component, allowing annuity account to grow tax-deferred before benefits are triggered, helping to increase the benefit payout amounts.
There are two main categories of annuities: immediate and deferred.
Purchased with a lump sum, benefit payments from immediate annuities are typically triggered within a year of purchase. Immediate annuities are commonly known as “Single Premium Immediate Annuities” and do not have an accumulated cash value component.
Deferred annuities are “deferred” in two ways. First, benefits are delayed for a period of time, during which the contract gathers cash value. Second, gains within the annuity account are tax-deferred until distribution, meaning that a consumer doesn’t incur a tax liability until benefit payments are triggered. This helps to accumulate more income that can then be used in retirement.
Several kinds of deferred annuities exist in the marketplace. Typically, they are identified by the means in which they gather cash value.
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In a Fixed Annuity (FA), the interest rate may change year to year as set by the insurance company, but usually there will be an ongoing minimum guaranteed rate. Traditional fixed annuities may be a good fit for individuals desiring steady, regular growth and regular benefit payments.
Fixed Indexed Annuity
In a Fixed Indexed Annuity (FIA), the contract’s interest rate is tied to the positive movement of a specific stock market index, such as the Dow Jones Industrial or the Standard and Poors 500. While the rate is based on index movement, a fixed indexed annuity has no direct involvement with the stock market. Fixed indexed annuities may be appropriate for individuals wanting upside potential, with guaranteed returns.
Deferred Income Annuity
A deferred income annuity (DIA) works in much the same way as other deferred annuities, with benefit amounts tied to the purchase amount (usually paid in a lump sum). Deferred income annuities involve a period of deferral and are typically structured to last the rest of an annuitant’s life. The longer the period of deferral, the more the benefits grow before distribution.
Among these categories, there may be other levels of customization and variation. One common and useful enhancement is the lifetime income rider. Typically available for additional fees, a lifetime income rider provides the annuitant a source of income that cannot be outlived.
Ultimately the right annuity and options for you will depend on your unique situation, objectives, and needs. This is why it is helpful to involve a knowledgeable financial professional when you begin retirement planning.