Understanding Annuities: What is an Annuity?

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Annuity Objectives ^Top

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Did you know that an annuity can be used to systematically accumulate money for retirement purposes, as well as to guarantee a retirement income that you cannot outlive?

In planning for financial security in retirement, an annuity can help satisfy two basic objectives:

What is an Annuity? ^Top

An annuity is a long-term savings plan that can be used to accumulate assets on a tax-deferred basis for retirement and/or to convert retirement assets into a stream of income.

While both are insurance contracts, an annuity is the opposite of life insurance: There are two basic types of annuities, depending on whether you need to accumulate assets for retirement or whether you're at or near retirement and interested in creating a lifetime retirement income:
Deferred Annuities
A deferred annuity has two distinct phases: the accumulation phase and the income phase.
Immediate Income Annuities
An immediate income annuity is purchased with a single premium and income payments begin immediately or shortly after the premium is paid.

How are Annuity Premiums Invested? ^Top

Depending on your investment objectives and risk tolerance, there are a variety of ways that you can choose to invest your annuity premiums:
  1. Fixed Interest Annuities
    A fixed interest annuity pays a fixed rate of interest on the premiums invested in the contract, less any applicable charges. The insurance company guarantees* that it will pay a minimum interest rate for the life of the annuity contract. A company may also pay an "excess" or bonus interest rate, which is guaranteed* for a shorter period, such as one year.
  2. Variable Annuities
    During the accumulation phase of a variable annuity, premiums less any applicable charges are placed in a separate account of the insurance company, where the annuity owner can invest them in one or more stock and bond subaccounts. During the income phase of a variable annuity, the amount of each income payment may be fixed and guaranteed*, or it may be variable, changing with the value of the investments in the separate account.
  3. Indexed Annuities
    An indexed annuity has characteristics of both a fixed interest annuity and a variable annuity. Similar to a variable annuity, the insurance company pays a rate of return on annuity premiums that is tied to a stock market index, such as the Standard & Poor's 500 Composite Stock Price Index. Similar to fixed interest annuities, indexed annuities also provide a minimum guaranteed* interest rate, meaning that they have less market risk than variable annuities. Since the minimum guaranteed interest rate is, however, combined with the interest rate linked to a market index, indexed annuities have the potential to earn returns better than fixed interest annuities when the stock market is rising.

A Closer Look at Equity-Indexed or Indexed Annuities ^Top

The indexed annuity is a hybrid of the fixed interest annuity and the variable annuity: An indexed annuity is an insurance contract and not an investment in the stock market. Indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. Any interest payable in excess of the minimum guaranteed* interest rate is determined by a formula contained in the annuity contract. This formula is determined by a variety of indexed annuity contract features, including:

Does it sound like a Fixed Indexed Annuity might be right for you?

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