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The Basics About Annuities

Everyone’s heard about annuities, but your eyes may glaze over when trying to figure out what they really do. Here’s a quick explanation. These are the four characteristics of annuities:
 
  • A deferred annuity is one in which you invest your money now, let it grow tax-deferred, and later withdraw it in a lump sum, in regular payments until the money runs out, or by rolling the money into an income annuity for ongoing income.
  • An income annuity (synonymous with “immediate” annuity) is one that begins making regular payments to you as soon as you put money into it. Income annuities are usually used by retirees to receive a regular, assured income for the rest of their lives.
  • A fixed annuity grows or makes payments at a fixed rate of return.
  • A variable annuity invests the annuity money in a variety of mutual funds of your choosing.

Therefore, there are actually four kinds of annuities based upon these characteristics:
  • Fixed deferred annuity – a tax-deferred investment account that grows in value based on a fixed investment return
  • Variable deferred annuity – a tax-deferred investment account that grows in value based on a variable investment return that depends on the performance of the underlying mutual funds selected for investment
  • Fixed income annuity – an investment account that makes fixed, regular payments to you, either for a certain period of time or for the rest of your life
  • Variable income annuity – an investment account that makes regular payments to you either for a certain period of time or for the rest of your life. The amount of the payments varies according to the performance of the underlying mutual funds. A recent trend in both variable deferred and variable income annuities is the ability to lock in stock fund gains, thus providing rising annuity values and payouts if the stock and other funds you choose for the annuities rise in value

This is the basic way that annuities are organized. But thanks to the ingenuity of the insurance industry, not to mention its desire to sell more annuities, all variations of the above menu are offered.
 
For example, an immediate fixed annuity may include an inflation kicker, and deferred variable annuities may have features that allow you to periodically lock in investment gains. Whether any of the additional bells and whistles is appropriate for you depends on your circumstances.
 
The best course of action, as with most financial products, may be to stick with the basics. There’s more competition among the insurance companies for the basic policies, which may help you get a better deal. Also, the newfangled policies are more difficult to evaluate and compare and, while some of the improvements may be beneficial to you, many experts in the field fear that there’s less than meets the eye with a so-called “new and improved” type of annuity.
 
All the information presented on AARP.org is for educational and resource purposes only. We suggest that you consult with your financial or tax adviser with regard to your individual situation. Use of the information contained in this Web site is at the sole choice and risk of the reader.

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