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With a fixed annuity, the issuing insurance company will guarantee both the principal and the earnings, and it will make fixed dollar payments throughout the chosen term of the contract.
With a variable annuity, the issuing insurer will guarantee a minimum amount of income payment. However, the remaining income payments will vary based on the performance of an underlying portfolio. This allows the opportunity for larger payments, but it can also present more risk.
The performance of an index annuity will be dependent upon an underlying market index, such as the S&P 500. These annuities allow for upside market opportunity (that is typically capped at a certain percentage), along with downside protection in a poorly performing market environment.
If the lifetime payout option is chosen, an annuity can provide an income for the remainder of an individual’s life – and if the joint life option is chosen, it will provide guaranteed lifetime income for a second named individual, such as a spouse or partner, as well. Because of this, an annuity can literally provide an income that cannot be outlived.
Due to the tax deferred aspect of annuities, interest can essentially compound on top of interest. In other words, because a prior year’s interest was not taxed, the investor can get the benefit of obtaining even more interest the following year on top of that, and so on.
Annuities have two key phases in their life spans. These include the accumulation phase and the annuitization phase.
The accumulation phase:
The accumulation phase is the period when the annuity holder is making deposits into the annuity. This may encompass a long period of time where many contributions are being made, or conversely, it may be just one large lump sum contribution.
The annuitization phase:
The annuitization phase is when the annuity starts to make income payments. This occurs when the money that has been deposited into the annuity is essentially converted over from savings into an ongoing income stream.
Annuities typically have a variety of different payout options to choose from. These can include:
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