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What are the types of annuity and how do they work?

Annuities are insurance contracts that can provide an income stream. There are many different varieties. Here’s what you need to know.

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You may be intimidated when you hear the word “annuity”.

Yes, these financial products can be complicated, but they are also one of the few sources of retirement income that can be guaranteed for life. (Guarantees are based on the solvency of the issuing company.)

An annuity is a contract issued by an insurance company. You make a lump sum payment or a series of payments to buy an annuity. In return, the annuity issuing company converts your payment or payments into an income stream for you.

Some also offer death cover, but this may vary depending on the type of annuity purchased, or in some types of annuity it may vary depending on the annuity option selected within that annuity.

“They’re designed for people approaching or entering retirement to provide a layer of security and protection,” said Todd Giesing, director of annuity research at the LIMRA Secure Retirement Institute.

Annuities come in several types. So it’s important to understand what you’re buying and whether a particular annuity is right for you.

Here are the most common types of annuities on the market and how they work:

In this article:

Deferred annuities

Deferred annuities are designed for long-term goals such as retirement. They come in three main varieties:

Deferred fixed annuity

A deferred fixed annuity offers a guaranteed interest rate, tax-deferred* growth and capital protection. It earns interest at a rate determined by the insurer, and the rate may change during the term of the contract. There is often a guaranteed lowest interest rate. Deferred fixed annuities are designed for conservative growth.

Deferred variable annuity

A deferred variable annuity offers tax-deferred growth potential, a range of investment choices and the potential for loss of value. Keep in mind that buying a variable annuity involves risk. The value of your contract may go up or down, depending on the performance of the underlying investments.

Deferred fixed index annuity

A deferred fixed index annuity credits interest to an index account based in part on the performance of an index, such as the S&P 500 Stock Index**. These annuities offer tax-deferred growth and market loss protection. They may give you the option of a higher interest rate than with a deferred fixed annuity, but it is also possible that there may be a year where you would receive zero interest. Interest is usually credited only once a year.

Income annuities

Income annuities provide guaranteed income from the day your premium is paid. They come in two main varieties:

Immediate Income Annuity

An immediate income annuity offers guaranteed income that begins within 12 months of the contract being issued. These annuities offer limited liquidity and are intended for immediate income needs. They can appeal to a person close to retirement with a lump sum of money and instead of spending it all at once, you can buy an income annuity to spread the money into payments over time.

It is important to note that once you pay into an annuity, you can only access that money as it is paid to you from the annuity as income.

Deferred income annuity

A deferred income annuity offers flexible purchase payments, guaranteed income that usually starts no earlier than 13 months after the contract is issued, and in most cases offers no liquidity (you can’t access the money you use to buy the annuity, but will receive it as income payments from the annuity ). It is intended for future income needs. Typically, the longer you wait to receive a payout, the larger it will be, Giesing says.

Innovations in deferred income annuities give people with aging parents peace of mind. AgeUp, a new type of annuity product created by a team at Haven Life and published by our parent company MassMutual, is designed to protect families from the financial risk of loved ones living into their 90s and beyond.

How to know if an annuity is right for you

Annuities can be a valuable tool for people who are close to or in retirement and want a guaranteed retirement income. But that doesn’t mean they’re ideal for all retirees.

You should also consider the various fees and charges that apply to annuities.

This is a high-level overview of common types of annuities. Because they can be complicated, it’s best to work with a financial expert to find out more and see if they fit with your retirement savings plan, says Giesing.

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About Cameron Huddleston

Cameron Huddleston is the author of Mom and Dad, We Need to Talk: How to Have Essential Conversations with Your Parents about their Finances. She is an award-winning journalist with more than 18 years of experience writing about personal finance. Her work has appeared in Kiplinger’s Personal Finance, Business Insider, Chicago Tribune, Forbes, MSN, Yahoo and many more print and online publications. US News & World Report named Cameron one of the top personal finance experts to follow on Twitter, and AOL Daily Finance named me one of the top 20 personal finance influencers to follow on Twitter. She has appeared on CNBC, MSNBC, CNN and “Fox & Friends” and has been a guest on ABC News Radio, Wall Street Journal Radio, NPR and more than 30 podcasts. Cameron has also been interviewed and quoted as an expert in The New York Times, Chicago Tribune, BBC.com, MarketWatch and more.

Read more by Cameron Huddleston

Our editorial policy

Haven Life is a customer-centric life insurance agency supported and wholly owned by Massachusetts Mutual Life Insurance Company (MassMutual). We believe that navigating life insurance decisions, your personal finances and overall well-being can be refreshingly simple.

Our editorial policy

Haven Life is a customer-centric life insurance agency supported and wholly owned by Massachusetts Mutual Life Insurance Company (MassMutual). We believe that navigating life insurance decisions, your personal finances and overall well-being can be refreshingly simple.

Our content is created for educational purposes only. Haven Life does not endorse the companies, products, services or strategies discussed here, but we hope they can make your life a little less difficult if they fit your situation.

Haven Life is not authorized to provide tax, legal or investment advice. This material is not intended to provide and should not be used for tax, legal or investment advice. Individuals are encouraged to obtain advice from their own tax or legal advisor.

Our disclosures

Haven Term is a term life insurance policy (DTC and ICC17DTC in some states, including NC) issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001 and offered exclusively through Haven Life Insurance Agency, LLC. In NY, Haven Term is DTC-NY 1017. In CA, Haven Term is DTC-CA 042017. Haven Term Simplified is a Simplified Issue Term Life Insurance Policy (ICC19PCM-SI 0819 in some states, including NC) issued by CM Life Insurance Company, Enfield, CT 06082. Police and driver form numbers and features may vary by state and may not be available in all states. Our agency license number in California is OK71922 and in Arkansas 100139527.

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