Annuities explained: fixed, indexed and income annuities

An annuity is a contract between you and an insurance company. You pay a lump sum or a series of payments, and the insurer agrees to credit interest on your money, pay you income, or both, starting now or at a future date. Fixed and fixed indexed annuities protect your principal from market losses, and income annuities can pay you for life. The trade-offs are less access to your money during a surrender period, and guarantees that rely on the financial strength and claims paying ability of the insurer that issues the contract. Annuities are insurance products, not bank deposits, and they are not right for money you may need soon.

The main types of annuities

Rise Up Benefits Group focuses on fixed, fixed indexed and income annuities, which are insurance products. Variable annuities are securities regulated by the SEC.

Another way to think about the types is by goal. Fixed and fixed indexed annuities are mainly about growing money safely before retirement. Immediate and deferred income annuities are mainly about turning money into a paycheck. Some contracts try to do both with optional riders.

How a fixed indexed annuity credits interest

This is the type people ask about most, and the type most often misunderstood. Your money is not invested in the stock market. Instead, the insurer looks at how an index performed over a set period and credits interest based on a formula: a cap, a participation rate or a spread.

If the index goes up, you receive part of that gain as interest, up to the limit. If the index goes down, you are credited zero for that period rather than a loss, and gains already credited are locked in. Caps and rates are set by the insurer and can change at each renewal, within limits in the contract.

Ask to see the current cap or participation rate, the minimum guaranteed rate in the contract, and how often the insurer can change the rate. A contract that looks generous in year one can renew at a much lower rate, so the guaranteed minimums matter.

Surrender periods and access to your money

Most deferred annuities have a surrender period, often several years, during which withdrawals above a free amount trigger a surrender charge that usually declines each year. Many contracts allow a free withdrawal each year, commonly around 10% of the value, but the terms vary.

Federal tax rules add another layer. Gains in an annuity grow tax-deferred and are taxed as ordinary income when withdrawn, and withdrawals before age 59 and a half may face a 10% federal tax penalty on the taxable part, with some exceptions.

Every annuity sold in Arizona includes a free look period, printed on the contract, during which you can cancel for a refund. Use that time to reread the contract at home, away from any pressure to decide.

• Keep emergency savings outside the annuity.
• Match the surrender period to how long you can truly leave the money alone.
• Read how the contract handles nursing home or terminal illness waivers, if any.

What backs the guarantees

Annuity guarantees, including protection of principal and lifetime income, are backed by the financial strength and claims paying ability of the issuing insurance company. They are not backed by the FDIC or any government agency. That is why the insurer’s financial strength ratings matter as much as the rate.

Arizona adds a safety net. If a licensed insurer becomes insolvent, the Arizona Life and Disability Insurance Guaranty Fund protects Arizona residents up to $250,000 in the present value of annuity benefits, including cash surrender and withdrawal values, per person, according to the Arizona Department of Insurance and Financial Institutions. The fund is a backstop, and insurers and agents are not allowed to use it as a selling point.

Every annuity sold in Arizona must come from an insurer licensed by the Arizona Department of Insurance and Financial Institutions. You can check an agent's license and an insurer's license with the Department, and you can file a complaint there if something goes wrong.

When an annuity may fit, and when it may not

• May fit: you want part of your savings protected from market losses.
• May fit: you want income you cannot outlive to cover essential expenses.
• May fit: you have money set aside for later and want tax-deferred growth.
• May not fit: you might need the money in the next few years.
• May not fit: you have no emergency fund outside of it.
• May not fit: you are buying it because someone promised market returns with no risk.

Questions to ask before you sign

• How long is the surrender period, and what are the charges each year?
• How much can I take out each year without a charge?
• What is guaranteed in writing, and what can change?
• What fees or rider charges apply?
• Who receives the value if I die, and how?
• What is the insurer’s financial strength rating?
• How long is my free look period to cancel for a full refund?

Income riders and lifetime income

Many fixed indexed annuities offer an optional income rider, sometimes called a guaranteed lifetime withdrawal benefit, for an annual fee. The rider sets a benefit base used only to calculate income, and once you turn it on, it pays a set amount each year for life, even if the account value runs out. The benefit base is not cash you can withdraw, and that distinction trips up many buyers.

An immediate or deferred income annuity takes a simpler route: you hand over a lump sum and receive a stream of payments, for a set period or for life, with fewer moving parts. Payments for life can last longer than your savings would, but you give up access to that lump sum. Options such as a cash refund or a period certain can make sure heirs receive something if you die early, in exchange for a lower payment.

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The bottom line

An annuity can be a useful tool for protection and lifetime income, as long as you understand exactly what you are buying. Visit our Annuities and Retirement Income page, then sit down with Viola. She will explain the contract line by line, compare insurers, and point you to your tax professional or financial advisor for questions outside insurance. Guarantees depend on the issuing insurer’s claims paying ability.