Understanding Annuities: Fixed, Variable, and Indexed Options

Annuities are financial instruments that provide a steady stream of income, typically during retirement. They come in various forms, each with its own unique features and risk profiles. In this blog post, we’ll explore the main types of annuities – fixed, variable, and indexed – to help you understand which option might be best suited for your financial goals and risk tolerance. 

Fixed Annuities 

Fixed annuities offer a guaranteed interest rate and fixed periodic payments, making them an ideal choice for conservative investors seeking stability. They are particularly beneficial for individuals nearing retirement or those who want to ensure a predictable income stream. 

Examples of Fixed Annuities: 

1. Straight Life Annuity: This type pays a fixed amount until the annuitant’s death. For instance, an individual might purchase a straight life annuity for $100,000, receiving $600 per month for life. However, if the annuitant passes away shortly after starting payments, the remaining funds do not go to beneficiaries. 

1. Joint Life Annuity: This annuity continues to pay out until both the annuitant and their spouse have passed away. For example, a couple invests $200,000 into a joint life annuity and receives $1,200 per month. Payments continue until both individuals are deceased, providing financial security for the surviving spouse. 

1. Term Certain Annuity: This annuity pays a fixed amount over a specified period. For example, a $50,000 investment might yield $400 per month for 10 years. If the annuitant dies before the term ends, the remaining payments can go to a designated beneficiary. 

Variable Annuities 

Variable annuities allow for investment in a variety of mutual funds, meaning the payout can fluctuate based on market performance. This type is suitable for investors who are comfortable with risk and seek the potential for higher returns. 

Examples of Variable Annuities: 

1. Investment in Mutual Funds: An investor might purchase a variable annuity with a $100,000 premium, allocating funds across several mutual funds. If the investments perform well, the account may grow significantly, leading to higher monthly payouts. Conversely, poor performance could result in lower payouts. 

1. Income Rider: Some variable annuities come with income riders that guarantee a minimum income regardless of market performance. For example, an investor might secure a guaranteed annual income of $5,000, even if the underlying investments decline in value. 

1. Market-Linked Payouts: An investor could choose a variable annuity linked to a specific stock index. If the index performs well, the investor benefits from increased payouts, but if it performs poorly, the payouts may decrease. 

Indexed Annuities 

Indexed annuities combine features of both fixed and variable annuities. They offer a guaranteed minimum return while also allowing for potential growth based on a specific market index, such as the S&P 500. This makes them appealing for those who want to participate in market gains without the full risk of variable annuities. 

Examples of Indexed Annuities: 

1. Participation Rate: In indexed annuities, a 70% participation rate means that if the S&P 500 rises by 10%, the investor receives a 7% return. Importantly, there is a guaranteed minimum return of 1% if the index is negative or below 1%. This minimum is not added to the credited return; it serves as a baseline, ensuring that if the credited return falls below 1%, the investor still receives at least a 1% return, providing protection against market downturns. 

1. Cap on Returns: An indexed annuity with a return cap limits the maximum return an investor can earn, even if the underlying index performs exceptionally well. This means that their potential gains are capped. For instance, if the S&P 500 rises by 12% but the annuity has a 5% cap, the investor will only receive a 5% return, missing out on the additional 7% of potential gains. 

1. Hybrid Features: Some indexed annuities come with additional features, such as a return of premium guarantee. For instance, if an investor contributes $100,000 and the market performs poorly, they can withdraw their initial investment without penalty after a specified period. 

When selecting an annuity, it’s crucial to consider your financial goals, risk tolerance, and time horizon. It’s also important to understand the fees and expenses associated with each type of annuity, as well as any surrender charges or restrictions on withdrawals. Consulting with a financial advisor can help you determine which annuity option best fits your unique financial situation and goals. 

This information was provided in part by the IRS website. 

Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Tyler Russell and not necessarily those of Raymond James. 

Investing involves risk and you may incur a profit or loss regardless of the strategy selected, including asset allocation and diversification. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. 

Investors should consider the investment objectives, risks, charges and expenses of investment companies and variable annuities and their underlying funds. This and other important information about investment companies and variable annuities are contained in the prospectus, which can be obtained from your financial advisor and should be read carefully before investing.