By: Andrew Rosen, CFP®, CEP®

As I eluded to in a previous blog, Understanding Annuities in 5 Minutes or Less, annuities can be a complicated animal.  There are certainly circumstances where they fit a need in one’s life and so I’d like to take a few moments to educate about the 4 main types of annuities.

Fixed Annuities

A fixed annuity is similar to a CD but instead of with a bank it is with an insurance company.  A fixed annuity will issue a contract and pay you a pre-determined interest rate until maturity while guaranteeing your principal.  Typically, the longer you are willing to lock in your dollars the higher the interest rate paid.  Like any annuity the dollars will accumulate tax deferred until withdrawal and also generally have some form of annuitization option if you so desire.  Since there is no FDIC insurance on these vehicles, like a CD, there are typically higher interest rates than you can receive with a bank sponsored equivalent investment.

Who are Fixed Annuities good for?

Fixed annuities are good for the investor who don’t have much risk at all, and lacks immediate liquidity needs.  They are great for the person who wants a slightly better rate than a CD.  In addition, if you are in a very high tax bracket you may find some value to the tax deferral.

Single Premium Immediate Annuity (SPIA)

Next on our list is a SPIA.  You are likely already more familiar with this than you think.  Essentially, a SPIA is no different than a pension or Social Security.  You give an insurance company a determined amount of capital and they’ll in turn give you a fixed guaranteed payment for a certain period of time or one’s lifetime.  They are extremely predictable, but in return for getting the guaranteed payments you give up control of your funds.

Who are Single Premium Immediate Annuities good for?

SPIA’s are commonly used when there is a retirement income need that must be met and a lump sum to do so.  You’ll also find these work well for individuals who don’t have a need to retain ownership of the funds after the term is up, thus settling for a fixed payment that doesn’t change is adequate.

Variable Annuities

Variable annuities are a diverse mix of annuities.  In the basic form you invest in mutual fund like investments called sub accounts that are tied to the markets like stock or bond portfolios.  The investment value will grow or shrink depending how well the investments perform.  In addition, there is usually some form of death benefit (more often than not the contributions minus withdrawals).

Unlike Fixed or SPIA annuities a variable annuity has many bells and whistles that can be added on.  Two of the most common features are enhanced death benefit rider, and an income rider.  The enhanced death benefit rider does what it sounds, it will give you a better payout at death then just premiums contributed.   The income rider, where we really see the most traction in these products, will have some income value that grows until needing to turn these funds into an income stream.  They’ll last for a certain period of time for you, or you and your spouse, and be based off of the income value depending on what age you decide to start collecting.  For instance, you may invest $100,000 the income value may be $200,000 and if your guaranteed withdrawal rate is 5% well then you’d receive $10,000/yr for as long as you live.  What will happen is first you’ll receive your funds back and then if you exacerbate your entire investment the insurance company will keep paying you out of their pocket until you pass away.  If you die with money still left in the product either your spouse will continue the income benefit, assuming you are in a spousal rider product, or your beneficiary will just inherit the remainder funds.

Who are Variable Annuities good for?

I find Variable annuities are good for people who want to take some risk off the table and have a portion of their retirement income needs met through a more predictable income stream.  They work well if these people still want to benefit from market performance with downside protection.  Additionally, they work nicely when someone wants to leave unused funds behind to their heirs, which usually comes with less guaranteed income then a SPIA where you give up full control.

The other type of person who variable annuities work for is one who has funds they don’t need to touch, but have some insurance needs but might not be insurable.

Fixed or Equity Indexed Annuity

These are by far the most confusing of the annuity family and thus tend to be misunderstood and misrepresented quite often.  These types of annuities are a hybrid between fixed and variable annuities.  There is generally some fixed floor on how low your returns can be and additionally a capped ceiling as well.  At the end of the term you can take your funds, get a new term, or turn into income.  Personally I am not the biggest proponent of these annuities, but in certain select circumstances may be appropriate compliment to an investment portfolio.

Who are Fixed or Equity Indexed Annuities good for?

I have a hard time pin pointing the appropriate person these are good investments for.  Sometimes they can offer a higher income guarantee than variable annuities while still maintaining ownership of the underlying investment.  These are basically the only times I’ve found them to be appropriate in my many years in this profession.

Like any investment annuities have their places they work well and their places they are not appropriate.  If investing in one make sure you grasp the nuisances and are well aligned with a financial planner whom you trust and understands your retirement needs.