Fixed vs. Variable Annuities
In a fixed annuity, the insurance company guarantees the principal and a minimum rate of interest. In other words, as long as the insurance company is financially sound, the money you have in a fixed annuity will grow and will not drop in value. The growth of the annuity’s value and/or the benefits paid may be fixed at a dollar amount or by an interest rate. Fixed annuities are regulated by the state insurance departments.
Money in a variable annuity can be invested in one or more funds, similar to mutual funds, but that are only open to investors who purchase an insurance company’s variable annuity product. These funds have different investment objectives, and the value of your money in the fund or funds chosen will fluctuate based on the performance (net of expenses) of those particular funds.
Variable annuities, the insurance companies that offer them and the registered representatives who sell them are regulated by state insurance departments and the federal Securities and Exchange Commission.
Types of Fixed Annuities
A fixed indexed annuity is a fixed annuity which looks like a hybrid between a variable annuity and a fixed annuity. It credits a minimum rate of interest, just as a fixed annuity does, but its total rate of return will be based on the performance of one or more indexes offered by the particular product. The interest credited is determined by changes in the index over a set period of time, generally 12 to 24 months, and is generally limited by a maximum rate cap or percentage of the total return.
A few annuities allow access to a portion of the annuity value during the first contract year without penalty, but the majority of annuities allow withdrawals of up to 10 percent of the contracts value starting in the second contract year.
Any withdrawals taken from tax qualified annuities (IRA, 403(b), SEP-IRA, etc.) are fully taxable whenever taken. Withdrawals taken from non-qualified annuities, those purchased with “after-tax” money, are considered to be your gain within the contract first and taxed as ordinary income. Once all gain has been paid out additional withdrawals are considered a return of your cost or premium and received income tax free. Any withdrawals taken from a tax qualified or a non-qualified annuity may be subject to a 10% tax penalty if withdrawn before age 59 1/2.
Other Types of Annuities
A deferred annuity allows premiums to be paid and interest earned until some point in the future when the balance may be withdrawn or paid out in some fashion. May be either a variable, fixed or fixed indexed annuity.
An immediate annuity is designed to begin paying an income at a contractually guaranteed point in the future. Generally how the income is to be paid out is directly related to when the first payment is to be received. For example, if the income is to be paid monthly the first payment will be made one month after the annuity is purchased.
A life only annuity pays an income to the owner for as long as they live. This type of contract can also be set-up as a joint arrangement so that the income continues until the second of the two annuitants has died.
A non-qualified annuity is one that has been purchased with “after tax” money. The earnings accumulate on a tax-deferred basis within the annuity, and are taxed as ordinary income when distributed. Any income taken before you reach age 59 1/2 may also be subject to an additional 10% tax.penalty.
A flexible premium annuity is one that may be purchased by one or more payments. Most companies will allow premium payments to be made at any time, but most also have a company limit on the amount of premium they will accept for an individual contract. Once a contract has been established, future premium payments are strictly at the digression of the contract owner.