What Are Annuities?

Annuities are a tax-deferred investment that is similar to life insurance in that they sometimes include a death benefit of a guaranteed minimum amount to a designated beneficiary. They grow tax-sheltered and you don't pay taxes until you withdraw the money. They are backed by the financial strength of the insurance company you make the purchase through. A conservative investor likes the idea of an annuity because you can convert the investment into a stream of periodic payments over the course of a lifetime and know exactly how much it will pay you and when. Annuities are contracts between the consumer and an insurance company, where you make one lump-sum payment, or a series of payments to the insurance company; and in return, the consumer will receive periodic payments from the company now or in the future.

There are both fixed and variable annuities. A fixed annuity will guarantee you a minimum interest rate during the time your annuity is growing. You can choose a fixed time period or an indefinite period (such as your lifetime), and the insurance company guarantees that you receive periodic payments at a guaranteed amount per dollar in your annuity. Fixed annuities are not securities and are not regulated by the SEC.

A variable annuity allows you to invest the amount of your payments across a range of various investment options – like mutual funds. The rate of return and the amount of periodic payments you receive will vary and depend on the performance of the investments you've selected for your annuity. Variable annuities can be expensive investments. You pay for an insurance component (often called mortality and expense risk charge) which is about 1.15%. There are also investment administration expenses that are paid annually which can be between .45% and 1.25%. These fees can reduce the variable annuities return. Variable annuities are securities and therefore regulated by the SEC.

Another type of annuity exists as well, called an equity-indexed annuity. When you are making your series of payments, or when you make a lump-sum payment, the insurance company will credit you with a return based on an equity index (perhaps the S&P 500 Composite Stock Price Index). You are guaranteed a minimum return by the insurance company, but the amount of your guaranteed minimum return will vary. You can choose to receive your payment as a lump-sum or through periodic payments. Most equity-indexed annuities are not registered with the SEC but the exact mix of features of the equity-indexed annuity may cause it to be a security (or not).

If you withdraw or surrender your annuities within the first six to eight years of opening them, there is a 6 to 8% surrender charge which declines if you leave the money in the account for a longer period of time.