Let’s assume that you don’t know what an annuity is, states Chris Sumner, Founder of RS Financial Group. No worries. Most everyone knows what life insurance is, so let’s just start by making a comparison to life insurance.
Life insurance protects against the risk of death, or dying too soon; if the insured person(s) die, the insurance company pays out a sum of money to one or more designated beneficiaries;
An annuity is sometimes referred to as “the opposite of life insurance.” Annuities insure against the risk of life, or living too long; the insured person receives a stream of income they cannot outlive from the insurance company.
Hold on- before making this decision, you should also consider a fundamental principal of risk:
Risk/Reward Tradeoff- a direct inverse relationship between possible risk and possible reward, which holds for a particular situation. To realize greater reward, one must generally accept a greater risk, and vice versa.
- What level of risk I am willing to assume with the annuity?
• If interested in high minimum guaranteed interest, regardless of the lower level of interest crediting/gains, consider a Fixed Annuity.
• If willing to accept a lower minimum guarantee than a fixed annuity, but looking for potentially greater interest crediting/gains, consider a Fixed Indexed Annuity.
• If willing to accept no minimum guaranteed interest, and the possibility of unlimited loss in exchange for the possibility of unlimited interest crediting/gains, consider a Variable Annuity.
- How soon will I need the regular stream of income payments from the annuity?
• If income will be taken within the first year, consider an immediate annuity (offered in Fixed, Fixed Indexed, and Variable types).
• If income will be taken at some time further in the future, consider a deferred annuity (offered in Fixed, Fixed Indexed, and Variable types).
- How many premium payments will I be making into the annuity?
• If only a single payment will be made into the annuity, consider a single premium immediate annuity or a single premium deferred annuity.
• If making more than one payment to the annuity, consider a flexible premium deferred annuity. There are also two different classifications of annuities: deferred and immediate.
- What is a deferred annuity?
An insurance product whereby at least a year will elapse between when the lump sum or series of premium(s) are paid, and the annuity is transitioned into a stream of income through annuitization. Deferred annuities can be Fixed, Fixed Indexed, or Variable in nature.
- What is an immediate annuity?
An insurance product whereby a lump sum premium is paid and the annuity is transitioned into a stream of income through annuitization within one year from the date of purchase. Immediate annuities can be Fixed, In-dexed, or Variable in nature.
Deferred annuities typically are used as vehicles for accumulation, or building additional interest until the annuitant is ready to transition the annuity to a series of payments through a process called “annuitization.” Alternatively, an immediate annuity is often used as a vehicle for individuals who are ready for their income stream to begin, well, immediately.