Traditional Fixed Annuity
Traditional fixed annuities offer a guaranteed minimum interest rate and guarantee your principal. These guarantees are backed by the claims paying ability of the insurance company that issues the contract. Interest rates vary from company to company, but most only guarantee their CURRENT rate for 12 months; after that, the money compounds at an “old-money” rate that is typically lower than the current rate. These contracts offer a number of guaranteed payouts called settlement options. These are typically irrevocable settlement options that often carry lower interest rates.
Indexed Fixed Annuity
These are also fixed in nature, in that they have a guaranteed principal. However the growth (or lack there-of) is tied to an index, typically the S&P 500 point-to-point movement over a 12 month period WITH NO DIVIDENDS. If the index goes up, your contract will pay some portion of that gain subject to a cap or participation rate…this is not guaranteed to stay the same. If the index is flat or has a loss, your contract will pay 0% for that 12 month period.
Both Traditional and Indexed annuities typically have surrender penalties that can range from
5-20+ years and be as high as 15%. An early withdrawal from a fixed annuity can result in the investor receiving LESS THAN THEY INVESTED. It is advised that all prospective fixed annuity buyers request and read a specimen contract prior to investing.
A Variable Annuity is also a contract between you and an insurance company, under which the insurer agrees to make periodic payment to you via settlement options as well. A variable annuity allows the contract holder to choose various investment options which will dictate the performance of the account. These options are sort of clones, if you will, of various different mutual funds that invest in stocks, bonds, or money market instruments. They do carry market risk similar to mutual funds.
Variable annuities also have guaranteed withdrawal benefits that can guarantee you a lifetime of income regardless of market performance. In addition, they carry a death benefit that guarantees your heirs that they won’t get less than what was invested.
It is generally accepted that if you are investing money INSIDE of an IRA or an employer sponsored plan, like a 403(b), it should not go to a variable annuity. Any tax-deferral benefit gained by investing into a variable annuity is negated because employer sponsored plans already grow tax deferred. See http://www.sec.gov/investor/pubs/varannty.htm for additional discussion.