Understanding common annuity terms can help you make educated decisions about your finances. There are several different types of annuities available, and each option may have unique features. To help you sort through the differences, here's an annuity glossary with some of the essential terms you should know.
With an immediate annuity, you purchase it from an insurance company, and you begin receiving income payments from your annuity immediately. That might be as soon as one month, or within the next year, depending on your contract.
Deferred annuities allow you to keep your money in an annuity contract. You can often let the money sit to potentially earn interest for many years until you're ready to start drawing income or taking withdrawals.
A fixed annuity is perhaps the easiest type of annuity to understand. You place money into the contract, and the insurance company pays you interest at a fixed, guaranteed rate.
Variable annuities fluctuate with value gains and losses in financial markets. The earnings you receive from your variable annuity will depend on how those investments perform, and it is possible to lose money if the investments decrease in value. You can often choose investments within the contract.
An indexed annuity typically offers a guarantee on your investment along with potential market index. For example, some contracts prevent you from losing money while providing growth potential through a market index such as the S&P 500. If the index performs well during specific periods, you might benefit from those gains to a limited degree and earn slightly more in your annuity.
With a single-premium annuity, you only make one premium payment into the contract. For example, when you purchase an immediate annuity, you pay a lump sum and begin taking income.
With flexible-premium contracts, you can add funds to your annuity multiple times. For example, you might establish monthly premium payments, or you might pay a lump sum at the end of every year (or whenever you choose). The more you put in, the more you'll potentially have later, depending on the gains or losses in your contract.
A rider is an optional feature that you can add to an annuity contract. Riders might provide growth guarantees, income guarantees, enhanced death benefits or other features. Not all annuities have riders, and those features typically come with additional costs, so consider speaking with a financial representative to determine which riders might make sense for you.
When you annuitize, you convert assets in your annuity contract into a stream of regular payments. This could be for a specific time period or it could be paid out over your lifetime.
10. Period Certain
If you're concerned about dying shortly after annuitizing, you can select a period certain. During that period, the insurance company pays you or your beneficiaries, regardless of when you die.
For example, you might choose a 10-year period certain. If you die in the year following annuitization, your beneficiaries continue to receive payments for nine more years.
11. Payout Phase
During the payout phase, an annuity contract pays income monthly, annually or on any other schedule available in the contract. Payments might last for your lifetime or for a specified number of years.
With variable annuities, a subaccount is an investment option available in the contract. Those options may have different risk and return characteristics, allowing you to choose an investment strategy that fits your needs and goals.
13. Surrender Charge
A surrender charge is a fee that insurance companies charge to discourage you from taking withdrawals shortly after purchasing certain types of annuities. The amount you pay is typically a percentage of your withdrawal, and surrender charges often decline over time until they're completely eliminated.
14. Surrender Period
The surrender period is a specified number of years, and if you withdraw too much from an annuity contract during this time period, you must pay a surrender charge. Not all annuities have surrender periods, and they may be four years, 10 years or another term.
The beneficiary receives assets in your annuity after your death. By designating a beneficiary, you might make the process of transferring assets faster and easier.
A Final Word
Annuities can be complicated or simple, depending on the products you choose and the goals you're working toward. If there are any annuity terms you don't understand, consider speaking with your financial representative.