The word “annuity” is defined as “an amount payable annually”. Specifically, an annuity refers to a contract offered by insurance companies allowing you to save funds for retirement on a tax-favored basis and then, if you want to, you can receive a guaranteed income payable either for life or for a certain time period.

Annuities are only offered by insurance companies that are licensed to underwrite life insurance and annuities in the state where you reside. Each such insurance company is a qualified legal reserve life insurance company subject to financial requirements that specify the minimum reserves the company must maintain on its policies.

Annuities are sold only by agents who are licensed by the states to sell life insurance. This includes every licensed life insurance agent in your state, as well as most financial planners and stock brokers.

In order to safeguard the funds of either its contract or policy owners, an insurance company has to meet strict financial requirements, which include establishing a reserve which must be equal to the withdrawal or surrender value of their total block of annuity policies or contracts. This means that the insurance company must set aside funds that are equal to the surrender value of every annuity contract in force. In addtion, along with these reserving requirements, state laws also require that there are certain levels of capital and surplus to further protect their contract holders or policy owners.

There are two broad classes of annuities, as well as numerous sub-classes of each class. The two broad classes are:

(1) Immediate annuities and

(2) Deferred annuities.

The sub classes include fixed deferred, variable, and equity-indexed annuities.

An immediate annuity is one where benefit payments begin quickly, usually within one year of the time it is purchased. The immediate annuity is usually purchased with a single premium.

With a deferred annuity, you pay a premium to the insurance company which then issues a contract that promises to pay interest or gains made on the deposit while deferring the income and the taxes until you actually begin to withdraw the money or begin receiving an income.

There are three major types of deferred annuities:

(1) Fixed Deferred Annuities

(2) Equity-Indexed annuities and

(3) Variable Annuities

A Fixed Deferred Annuity is basically a contract between you and the insurance company paying a guaranteed current interest rate. The interest rate may be guaranteed for one or more years and earns compound interest. These interest earnings are compounded on a tax-deferred basis. Fixed deferred annuities are offered either on a single premium basis, meaning that you give the insurance company a lump sum premium payment, usually $5,000 or more; or on a flexible premium basis, meaning that you pay a lower re-occurring premium payment on a monthly, quarterly, or annual basis. In addition to tax deferral, fixed deferred annuities offer safety for your premium. Fixed deferred annuities also offer a current interest rate which cannot be less than a lifetime minimum guaranteed interest rate, which is about 3%. The current interest rate is declared and guaranteed by the insurance company. Therefore, your premium in a fixed deferred annuity is not subjected to market risk associated with volatile financial markets.

Fixed deferred annuities have penalties for early withdrawal. These are known as surrender or withdrawal charges. These charges decline over the length of the surrender change period.

The advantages of a fixed deferred annuity are the safety of premium and tax deferral. Generally, fixed deferred annuities appeal to a risk averse investor who seeks to accumulate or preserve funds for retirement with a guarantee of premium, competitive fixed rate interest guarantees, and no market risk to the premium.

The main disadvantage of a fixed rate deferred annuity is that fixed rate guarantee-type products provide lower gains than those historically available in the equity markets. Many factors are important in determining whether a fixed rate deferred annuity is right for you. These factors include your age, retirement goals, and aversion to risk. If you are older and close to retirement or just desire to preserve your accumulated assets in a safe vehicle, then a fixed deferred annuity is probably your best choice. However, if you are younger and want to accumulate significant funds for your long-term retirement needs and are willing to take greater risks, then an equity-indexed or variable annuity might be a better alternative at the present time.

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