An annuity is a contract between you and an insurance company that requires the insurer to make payments to you, either immediately or in the future. You buy an annuity by making either a single payment or a series of payments. Similarly, your payout may come either as one lump-sum payment or as a series of payments over time.
- Periodic payments for a specific amount of time.This may be for the rest of your life, or the life of your spouse or another person.
- Death benefits. If you die before you start receiving payments, the person you name as your beneficiary receives a specific payment.
- Tax-deferred growth. You pay no taxes on the income and investment gains from your annuity until you withdraw the money.
FIXED vs. INDEXED
- Fixed Annuity. An insurance product that promises a minimum rate of interest while your account is growing. The insurance company also guarantees that the periodic payment will be for a set amount for a fixed period of time, such as 20 years, or an indefinite period, such as your lifetime.
- Indexed Annuity. This insurance product combines features of securities and insurance products. The insurance company credits you with a return that is based on a stock market index, such as the Standard & Poor’s 500 Index.
While Fixed Annuities are rather straight forward, an indexed Annuity is a bit more complex. An indexed Annuity generally promises to provide returns linked to the performance of a market index. There are two phases to an annuity contract – the accumulation (savings) phase and the annuity (payout) phase.
- During the accumulation phase, you make either a lump sum payment or a series of payments to the insurance company. You can allocate these payments to one or more indexed investment options. The insurance company credits your account with a return that is based on the indexed investment option’s return.
- During the annuity phase, the insurance company makes periodic payments to you. Or you can choose to receive your contract value in one lump sum.
Different indexed annuities use different indexing methods. Indexing methods determine how the change in the variable annuity’s return is determined at the end of each time-period. This return is then applied to your indexed annuity.
Some common indexing methods include:
Point-to-point. This method compares the index level at two points in time, such as the beginning and ending dates of the time-period.
Averaging. This method compares an average of the index levels at periodic intervals during the time period to the index level at the beginning of the time-period.
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