The Basic Types of Annuities
Annuities are contracts with an insurance company that provide certain benefits. There are many types of annuities out there and the terminology and usage can be confusing. This article provides and overview of the basic types of annuities and their variations.
Quick Annuity Primer
Base Contract: Every annuity starts with a base contract. The base contract has certain guarantees embedded it such as minimum interest rates, annuitization factors, fees, surrender charges, how the cash value can be invested.
Riders: Some annuities have the option to add riders. Riders are additional features that can be added to the base contract to provide additional income benefits, death benefits, or cash value growth features.
Annuities are differentiated by three categories:
- How the Annuity was Purchased: Single Premium or Flexible Premium
- When do Payments Begin: Immediate or Deferred
- How Contract Values are Invested: Fixed rates or Variable returns
Annuity Types
Income Annuities
Income annuities are some of the most basic types of annuities. Basically, you give the insurance company a sum of money and they pay out guaranteed income based on the agreed upon terms. There are no riders or other complicating features.
There are two important things to remember about Income Annuities:
1) When you enter into an income annuity, the terms are set at the beginning of the contract and generally cannot be changed.
2) There is no cash value meaning you cannot just request your premium to be sent back (after certain periods).
Single Premium Immediate Annuity (SPIA)
A SPIA is a contract where you give the annuity company a sum of money in exchange for a guaranteed stream of income. To be classified as a SPIA, the income must begin within 12 months of the initial premium.
Duration: The stream of income can be for life or for certain periods of such as 10 years.
Primary Return Mechanism: Insurance General Account, Mortality Credits, Return of Principal.
Deferred Income Annuity
(DIA)
A DIA is practically the same as a SPIA except that the income begins more than 12 months into the future.
Duration: The stream of income can be for life or for certain periods of such as 10 years.
Primary Return Mechanism: Insurance General Account, Mortality Credits, Return of Principal.
Qualified Longevity Annuity Contract (QLAC)
A QLAC is a special type of DIA for tax qualified accounts that allows you to defer income until up to age 85.
Duration: The stream of income can be for life or for certain periods of such as 10 years.
Primary Return Mechanism: Insurance General Account, Mortality Credits, Return of Principal.
For illustrative purposes only. Income amounts are made up but reflect the overall trend.
Fixed Deferred Annuities
Multi-Year Guaranteed Annuity (MYGA)
A MYGA is an annuity contract that guarantees a particular interest rate for a certain time period. They are effectively the insurance version of a bank Certificate of Deposit.
Duration: Most MYGA’s are between 1 and 10 years but can be rolled over in to new MYGA’s upon maturity.
Primary Return Mechanism: Insurance General Account
Principal Protection: Yes
Fixed Annuity (FA)
A Fixed Annuity is a contract that just provides an interest rate return for the cash value. It is essentially a bond of the annuity company where you will receive interest. However, the interest rates can fluctuate over time as typically only the first contract year is fully guaranteed.
Duration: Open until the annuity is closed.
Primary Return Mechanism: Insurance General Account
Principal Protection: Yes
Indexed Annuities
Indexed annuities are annuities where the return of the contract is based on the return of an underlying index subject to different terms as summarized here:
Cap: The maximum return possible in the event of the index gaining.
Participation Rate: If the index is up, how much you participate in that.
Spread: If the annuity is up, how much the insurance company will keep before giving you a return on the index.
Buffer: The downside protection in the event of the index losing.
Floor: The maximum loss possible.
Term: The timeframe that the index will be measured with options for step ups or point to point measurement along the way
Fixed Indexed Annuity (FIA)
Fixed Indexed Annuities (FIA) guarantees principal protection but offers returns based on the index subject to a cap. As the FIA provides full downside protection, the cap rates are lower than what is available on RILAs.
Return Mechanism: Options Contracts and General Account
Principal Protection: Yes
Registered Indexed Linked Annuity (RILA)
Registered Indexed Linked Annuities (RILA) typically do not provide principal protection though they can sometime be structured to mimic an FIA. Because you can lose principal, you are able to obtain higher cap rates which could increase long term return.
Generally, you are given the option of a cap rate along with either a buffer or a floor which has different potential outcomes and return profiles.
Return Mechanism: Options Contracts and General Account
Principal Protection: Not usually
Return Profiles
Variable Annuities
Variable annuities at their core are contracts that allow you to invest in sub-accounts in order to generate a return. Sub-accounts are similar to mutual funds in that they are broadly diversified funds that can invest in stocks, bonds, and real estate. In fact, many mutual funds have a sub-account equivalent.
Primary Return Mechanism: Sub-Account Performance
Principal Protection: None
Deferred Annuity Riders
Most deferred annuities can have riders associated with them to generate income other than annuitizing the contract. These riders can provide income for life which still maintaining access to the cash value of the contract.
Riders come with an additional fee above and beyond the base annuity contract.