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May 5, 2016

Annuities Explained

Annuities Explained

An annuity is a contract where in exchange for payment an insurance company provides a regular, stream of income to the individual who makes the payment. An annuity is especially attractive to provide retirement income. There are three popular types of annuities – fixed, variable and indexed.

Fixed Annuities Explained

A fixed rate annuity offers the lowest risk of any annuity. A fixed rate annuity locks in a guaranteed rate of return for a period of time. The guaranteed return on the initial investment makes fixed annuities a perfect investment for those with a low tolerance for risk or those with a short time before they need access to the funds. The investor gets a decent return and the return is tax deferred until they begin to withdraw the money.

Fixed rate annuities can be immediate or deferred. The immediate annuity starts making payouts as soon as funds are deposited. The deferred annuity allows payments to the annuity over a period of years and payouts beginning at a date in the future.

Fixed rate annuities work well for older investors who value a sure, safe return and do not want to deal with managing investments.

Variable Annuities Explained

A variable annuity allows you to determine the make-up of your portfolio. The premium can be divided into sub-accounts and invested in various market segments with different levels of risk. Investment options, in order of risk include money market, bonds, mutual funds, and international equities. Variable rate annuities can be bought with one payment or over time. Variable annuity payouts vary depending on your investment choice and market performance.

Most variable annuities are deferred — accumulating and compounding interest 5 or more years, however, immediate variable annuities are available.

The advantages of a variable annuity are greater returns and the risk is a loss on your investment. The longer term your investment the less volatile the return is likely to be. The disadvantages can be excessive management fees, surrender charges, and limited withdrawal allowances. Read your contract carefully before purchasing a variable annuity. Variable rate annuities are a good option for younger investors, investors who are less risk averse, or those who want to actively manage their investment.

Indexed Annuities Explained

Indexed annuities have a rate tied to a financial market index, typically an equity-market index like Standard & Poor’s 500 index of stocks. The advantages of the indexed annuities are potentially an average return higher than fixed annuities or fixed-income assets, a risk reduction factor that allows the investor to give up higher returns in exchange for a return minimum guarantee, reducing the variance of returns on both the high and the low end.

Indexed annuities are a good fit for some investors and not for others, depending on the value the investor places on yield and risk-reduction.

Selecting the Right Annuity

Before you make a decision as to which annuity type best meets your retirement, financial goals and needs study the options and ask a financial consultant who you trust to explain the advantages and disadvantages of each annuity in your specific situation.

An article by Steven Parsley
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