An annuity is a contract between you and an insurance company in which the company promises to make periodic payments to you, starting immediately or at some future time. You buy an annuity either with a single payment or a series of payments called premiums.
Some annuity contracts provide a way to save for retirement. Others can turn your savings into a stream of retirement income. Still others do both. If you use an annuity as a savings vehicle and the insurance company delays your pay-out to the future, you have a deferred annuity. If you use the annuity to create a source of retirement income and your payments start right away, you have an immediate annuity.
Annuities come in a few varieties: fixed, variable and indexed.
With a fixed annuity, the insurance company guarantees both the rate of return (the interest rate) and the payout to the investor. Although the word “fixed” might suggest otherwise, the interest rate on a fixed annuity can change over time. The contract will explain whether, how and when this can happen. Often the interest rate is fixed for a number of years and then changes periodically based on current rates. Payouts can be for an entire lifetime, or you can choose another time period.
While you are accumulating assets in a deferred fixed annuity, your investment grows tax-deferred. The insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. With an immediate fixed annuity—or when you “annuitize” your deferred annuity—you receive a pre-determined fixed amount of money, usually on a monthly basis (similar to a pension). These payments may last for a specified period, such as 25 years, or an unspecified period such as your lifetime or the lifetime of you and your spouse.
The predictability of a fixed annuity makes it a popular option for investors who want a guaranteed income stream to supplement their other investment and retirement income. Fixed annuity payouts are not affected by fluctuations in the market, so they can provide peace of mind for investors who want to ensure that they will have enough money to carry them through retirement and cover identified future expenses.
Fixed Annuity Guaranteed Income Disclosure from Section 12.19 of the Communications with the Public Guidelines:
Although it is possible to have guaranteed income for life with a fixed annuity, there is no assurance that this income will keep up with inflation. There is a surrender charge imposed generally during the first 5 to 7 years or during the rate guarantee period.
Fixed Index Annuities
Indexed annuities (aka “equity-indexed annuities” or “fixed-indexed annuities”) are complex financial instruments that have characteristics of both fixed and variable annuities. Indexed annuities offer a minimum guaranteed interest rate combined with an interest rate linked to a market index, hence the name.
Many indexed annuities are based on broad, well-known indices like the S&P 500 Composite Stock Price Index. But some use other indexes, including those that represent other segments of the market. Some indexed annuities allow investors to select one or more indexes. Because of the guaranteed interest rate, indexed annuities give you more risk (but more potential return) than a fixed annuity, but less risk (and less potential return) than a variable annuity.
Fixed Index Annuities Disclosure from Section 12.20 of the Communications with the Public Guidelines:
Index annuities are insurance contracts that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company, not an outside entity. Investors are cautioned to carefully review an index annuity for its features, costs, risks and how the variables are calculated.
Deferred Variable Annuities
Deferred variable annuities are hybrid investments containing securities and insurance features. Their sales are regulated both by FINRA and the Securities and Exchange Commission (SEC). These annuities offer investors choices among a number of complex contract features and options.
Due to the complexity and confusion surrounding them, which can lead to questionable sales practices, variable annuities are a leading source of investor complaints to FINRA.
FINRA developed Rule 2330 (Members’ Responsibilities Regarding Deferred Variable Annuities) to enhance firms’ compliance and supervisory systems, and provide more comprehensive and targeted protection to investors who purchase or exchange deferred variable annuities.
FINRA Rule 2320 (Variable Contracts of an Insurance Company) contains important requirements regarding cash and non-cash compensation arrangements associated with variable annuity sales.
Variable Annuities Disclosures from Section 12.53 of the Communications with the Public Guidelines:
There is a surrender charge imposed generally during the first 5 to 7 years that you own a variable annuity contract. Withdrawals prior to age 59½ may result in a 10% IRS tax penalty, in addition to any ordinary income tax. Investment sub-account values will fluctuate with changes in market conditions.
An investment in a variable annuity involves investment risk, including possible loss of principal. Variable annuities are designed for long-term investing. The contract, when redeemed, may be worth more or less than the total amount invested. Variable annuities are subject to insurance-related charges including mortality and expense charges, administrative fees, and the expenses associated with the underlying sub-accounts. Investors should consider the investment objectives, risks and charges and expenses of the variable annuity carefully before investing. The prospectus contains this and other information about the variable annuity. Contact your financial professional to obtain a prospectus, which should be read carefully before investing or sending money.