There are many misconceptions about annuities. In this podcast episode we discuss the different types of annuities and the benefits and negatives to each.
What Is a Fixed Annuity?
A fixed annuity is a type of insurance contract that promises to pay the buyer a specific, guaranteed interest rate on their contributions to the account. By contrast, a variable annuity pays interest that can fluctuate based on the performance of an investment portfolio chosen by the account’s owner. Fixed annuities are often used in retirement planning.
KEY TAKEAWAYS
- Fixed annuities are insurance contracts that pay a guaranteed rate of interest on the account owner’s contributions.
- Variable annuities, by contrast, pay a rate that varies according to the performance of an investment portfolio chosen by the account owner.
- The earnings in a fixed annuity are tax deferred until the owner begins receiving income from the annuity.
What Is A Variable Annuity?
A variable annuity is a contract between you and an insurance company. It serves as an investment account that may grow on a tax-deferred basis and includes certain insurance features, such as the ability to turn your account into a stream of periodic payments. You purchase a variable annuity contract by making either a single purchase payment or a series of purchase payments.
A variable annuity offers a range of investment options. The value of your contract will vary depending on the performance of the investment options you choose. The investment options for a variable annuity are typically mutual funds that invest in stocks, bonds, money market instruments, or some combination of the three.
Each variable annuity is unique. Most include features that make them different from other insurance products and investment options. Keep in mind that you will pay extra for the features offered by variable annuities.
First, variable annuities have insurance features. For instance, if you die before the insurance company starts making income payments to you, many contracts guarantee that your beneficiary will receive at least a specified amount. This is typically at least the amount of your purchase payments. It may also offer additional insurance features such as promising you a certain account value or the ability to make withdrawals up to a certain amount each year for the rest of your life.
Second, variable annuities are tax-deferred. That means you pay no federal taxes on the income and investment gains from your annuity until you make a withdrawal, receive income payments, or a death benefit is paid. You may also transfer your money from one investment option to another within a variable annuity without paying federal tax at the time of the transfer. When you withdraw your money, however, you will pay tax on the gains at ordinary federal income tax rates rather than lower capital gains rates. Under certain circumstances, the death benefit may not be subject to federal estate tax. In general, the benefits of tax deferral may outweigh the costs of a variable annuity only if you hold it as a long-term investment.
Third, variable annuities let you receive periodic income payments for a specified period or the rest of your life (or the life of your spouse). This process of turning your investment into a stream of periodic income payments is known as annuitization. This feature offers protection against the possibility that you will outlive your assets.
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