Are All Annuities Created Equal?

Annuities are types of investments and can offer secure, tax-deferred income for both savings and retirement. While they may seem complicated, annuities are simply contracts with insurances companies and not all annuities are created equal. You pay in a certain amount and the insurance company pays it out to you over a certain length of time. Contributions made to an annuity are tax-free, the funds are only taxed when the money is paid out, usually when you are at a lower tax rate.

You can contribute to an annuity in one lump sum or as regular payments over a period of time. This is known as the accumulation phase. The insurance company agrees to pay out the money, at a certain rate, called the payout phase. Not all annuities are created equal, although they all have the same structure and theory, there are three types of annuities:

Fixed
A fixed annuity fixes the interest rate and payout period. Everything is clearly defined and there is no fluctuation. These are the most secure of the available types of annuities and are good for long-term saving, investing and retirement. The rate of return is lower than the other types of annuities but the security and safety is higher.

Variable
A variable annuity is based on a wide range of investments, usually stock mutual funds. The money in the annuity is effectively invested in those securities and the payout and growth is based on the performance of the securities. A variable annuity adds more risk, but offers a higher possible payout. Most variable annuities have limits to the losses you can face, normally you will not lose the amount you actually contribute.

Indexed
The third type of annuity is an indexed annuity, which invests in and pays off based on the performance of a financial index, like the Dow Jones Industrial Average. The rate of return is directly linked to the performance of the index. For the most part, these indexed annuities represent a good compromise linking the security of an annuity with the long-term growth potential seen in stock indices over the last 50 years.

All annuities carry charges, costs and fees which can be substantial and may severely impact your rate of return. Review the paperwork carefully and check for fees and charges. Annuities also offer upgrades and options, which can provide death benefits, long-term care and other benefits. Review the cost of these upgrades as they are sometimes more expensive than simply getting separate coverage.