Annuities

Essentially, an annuity allows your initial investment of capital to become an income stream for you. Annuities are usually offered by insurance companies, who use the money as capital (much like banks use savings accounts). There are essentially two types of annuities: fixed and variable.

Fixed Annuities

Fixed annuities offer a guaranteed return on investment (ROI) paid out over a fixed period of time. The ROI is guaranteed because your funds go into low-risk investments whose returns are usually steady, such as government bonds. Fixed annuities can also be annuitized, meaning that payments continue until the account holder’s death. Payments on an annuitized plan are based on your life expectancy, which insurance companies are naturally used to determining.

Variable Annuities

Variable annuities differ from fixed annuities in several ways, most notably that their ROI is not guaranteed. Your money is invested in stocks and bonds, placing it at higher risk than the relatively safer fixed annuities, but the ROI can in turn be much higher. Also, variable annuities function like IRAs in that your earnings aren’t taxed until they’re withdrawn, and after retirement, you can be paid according to how well your investments in the annuity performed. Money invested through the annuity isn’t tax deductible, unlike traditional IRAs, but you also aren’t limited to how much you can contribute. Variable annuities also have attached insurance policies that guarantee the full amount of the principal will be paid out to the policyholder’s beneficiary after death.

Other Annuities

There are two other types of annuities that act as a mixture of fixed and variable annuities, though they’re much rarer and generally effective only in certain circumstances.

The first is a variable investment annuity with immediate payout, like a fixed annuity with the principal in higher-risk investments. The monthly payout can fluctuate greatly based on the earnings generated by those investments and is generally not worth the trouble of setting up an annuity in the first place.

The second is a fixed investment annuity with deferred payout, which is just like a fixed annuity that doesn’t pay you until retirement. This is essentially an IRA without tax deferment; an IRA is a much more worthwhile investment.

Liquidity of Annuities

Fixed annuities pay out monthly, but there are limitations that apply. They allow you to withdraw interest or a certain percentage of your principal each year, for instance, and often you will incur a surrender charge if you want to get the entirety of your principal back. Variable annuities work like IRAs; thus, their payouts are deferred until retirement or death. Annuities vary widely between insurance companies and even between individual contracts, so make sure you read the fine print.