Understanding the Different Types of Annuities

An annuity is a low-risk investment product where an individual makes a lump sum payment to an insurance company at the start. This initial amount remains fixed, with additional payments made over time based on the individual's choice. The invested premium generates profits used to fund payments to the annuitant. Traditional annuities offer guaranteed income post-retirement until the specified benefit period or the annuitant's death, ensuring financial security during retirement.

Originating in 1720 to support widows of ministers, annuities became publicly available in 1912 through insurance companies. Notable figures like Benjamin Franklin and Babe Ruth have utilized annuities. Various types of annuities exist, combining features of insurance and investment instruments, issued exclusively by licensed life insurance firms. Private annuities involve contractual agreements with non-profit groups, regulated by tax authorities.

The Securities and Exchange Commission oversees variable annuities. An annuity process includes two stages: deposit of funds and payout commencement—either immediately or deferred. Payments may continue until the end of the term or the annuitant's death. Some annuities offer death benefits. Immediate annuities start payouts right after initial investment, while deferred ones delay payments, allowing funds to grow tax-deferred. Typically used as pension plans, these payments include principal and income, often tax-free in tax-advantaged accounts like IRAs.

Periodic annuities pay for set years, with the risk that the annuitant may outlive the payments. Lifetime annuities, offering payment plans for life, function similarly to loans, with payments comprising principal and gains taxed as ordinary income. They act as longevity insurance, especially suited for uncertain life expectancy. Variations include increased payments, spouse or family rider options, and reversionary clauses providing income to beneficiaries after the annuitant’s death.

If the annuitant dies early, some contract variants allow for refunding or guaranteeing payments, but typically, unclaimed investments are forfeited. Long-term or impaired-life annuities offer higher payouts for individuals with shorter life expectancies. The price of lifetime annuities depends on expected longevity. Deferred annuities purchased during retirement begin payouts after 20 years, serving as long-term savings vehicles. These grow tax-deferred and can be fixed or variable, offering minimum returns while allowing investment flexibility.