Annuities: Types & Definitions
An annuity is a contract with an insurance company in which you agree to pay the insurance company an amount of money (a “premium”), and they agree to make payments to you of a specified amount, with a specified frequency, for a specified period of time.
Lifetime vs. Specific Period
Many annuities are lifetime annuities, which means that you receive a payment for the rest of your life. For example, the insurance company promises to pay you $1,000 every month until you die.
You can also have a joint lifetime annuity, also know as a joint annuity. This annuity is one which the insurance company promises to pay a certain amount every period until both you and the other annuitant (usually your spouse/partner) have passed away.
Some annuities aren’t lifetime annuities at all, these are term certain annuities. They simply pay out a set amount for a fixed number of years, at which point the payments stop. For example, you could purchase a 10-year annuity that would make payments every month or every year for 10 years.
Annuities protect against longevity risk, which is where your life expectancy and actual survival rate exceed expectations of your investment. In this case, the insurance company promises to provide income for as long as you live instead of the possibility of you outliving your money.
Fixed Annuities vs. Variable Annuities
Fixed annuities pay a fixed amount over the life of the annuity, but just because it is a fixed annuity doesn’t necessarily mean that its payout never changes. You can buy fixed annuities with payouts that increase at a given rate each year — say, 3% — or that increase in keeping with inflation.
Variable annuities are essentially an insurance product wrapped around a portfolio of investment funds. They typically promise to pay a fixed amount each period, with the potential for that amount to increase if the underlying funds perform well.
Immediate Annuities vs. Deferred Annuities
With an immediate annuity, you will begin to receive regular payments from the insurance company immediately after you pay the premium.
With a deferred annuity, there’s a delay between the time at which you pay the premium(s) and the time at which the insurance company begins to send you payments.
Single Premium Annuities vs. Multiple-Premium Annuities
With a single premium annuity, the premium or deposit is made as a single lump-sum. You make one payment to the insurance company, and they start making payments to you at the agreed-upon date.
Other annuities can require you to pay premiums over a period of time. For example, a multiple premium annuity, might require you to pay a premium every month or once a year for a 10-year period or perhaps until age 65, at which point you stop making payments and the insurance company starts making payments to you.