Annuity Basics

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Annuity Basics

An annuity is a contract with an insurance company. When you buy an annuity, you agree to make payments—known as premiums—to the company in exchange for which the insurance company agrees to make payments to you at a later time for a specified period. The time during which you pay premiums is called the accumulation period; you might pay your premium in one lump sum or in installments over the course of many years. The person who receives the benefit payments is known as the annuitant; this person is usually (though not always) the owner of the annuity.

When the accumulation period is over, the company begins distributing your funds. Either you can receive them in one lump sum, or you can choose to annuitize your funds. If you annuitize, the insurance company begins paying the annuitant a regular income, usually on a monthly basis, for a term known as the payout period.

Several types to choose from

There is a variety of payout options available for annuities:

• The annuitant can receive all of the funds at once in a lump sum payment.
• A life annuity makes payments of regular income for as long as the annuitant lives.
• Joint and survivor annuities make payments for the life of the annuitant and a beneficiary, such as a spouse.
• Period certain annuities make regular payments for a set term, whether or not the annuitant dies.
• Life with period certain annuities pay regular income as long as the annuitant lives, or pay a beneficiary if the annuitant dies within a certain term.
• Refund annuities pay to beneficiaries any value left in the annuity when the annuitant dies.
• Interest-only annuities pay the interest on the account value to the annuitant, who can then withdraw all the funds from the account as a lump sum when he or she chooses.

Annuities: fixed or variable

With traditional fixed annuities, the insurance company invests your premium in its general account. Whatever payout option you select, the interest gains and payment amounts are guaranteed by the insurance company, which assumes the risk of investing the general account.

With variable annuities, however, your premiums buy units in your choice of separate accounts, which then invest in stocks, bonds, and money market funds. Your payout will depend on the performance of the underlying securities in the separate accounts in which your premium is invested. Unlike fixed annuities, the value of your account is not guaranteed—you assume the risk involved in investing your premiums in exchange for potentially higher returns.