Annuities

An annuity is a contract between you (the purchaser or owner) and the issuer (usually an insurance company). In its simplest form, you pay money to the annuity issuer, the issuer invests the money for you, and then the issuer pays out the principal and earnings back to you or to a named beneficiary.

	Fixed annuity
	Historically, fixed annuities were the only type of annuities that companies issued. A fixed annuity pays a fixed, set rate of interest, which could change periodically, on the money invested in the annuity. In many cases, the annuity issuer will pay a guaranteed minimum rate of interest on the annuity account but also hold out the possibility that it will pay a higher rate of interest if market conditions permit (i.e., interest rates have risen on other money market instruments). To induce people to purchase fixed annuities, many issuers also will pay a much higher rate of interest for an initial period of time - usually a year. This higher rate of interest is sometimes called a bonus interest rate. Thus, the issuer may agree to pay 6 percent for the first year and then pay no less than 3 percent annually on the annuity after the first year. Usually, the annuity issuer will pay more than the minimum guaranteed rate on the fixed annuity. Fixed annuities are conservative investments for individuals who prefer fixed rates of return on their investments.
	Variable annuity
	Instead of receiving interest on the money invested in your annuity, you may choose a variable annuity that allows you to invest your annuity money in one or more investment sub-accounts. The sub-accounts (often called variable sub-accounts, flexible accounts, or flexible sub-accounts) will then invest in stocks, bonds, money market instruments, and other types of investments. Many variable annuity issuers may offer 6 to 10 different sub-accounts. The annuity issuer will allow you to allocate your money among the different accounts in any way that you desire. Furthermore, most annuity issuers allow you to move money from one sub-account to another without incurring commissions (and there are usually no tax consequences). With a variable annuity, the amount of earnings that will be credited to your annuity account will depend on the performance of the underlying sub-accounts. Unlike a fixed annuity, you assume the investment risk on the annuity. Some years you may do very well, while in others you may lose money. In recent years variable annuities have become very popular as people have been more willing to take the added risk to try to pursue higher returns than what is available on fixed annuities.
	Equity-indexed annuity
	A third broad type of annuity is an equity-indexed annuity. This type of annuity is sort of a hybrid between a fixed annuity and a variable annuity. When you purchase an equity-indexed annuity, the issuer agrees to pay a return on your account that is tied to a stock market index - usually the S&P 500. However, the issuer also guarantees to pay you no less than a certain return in a given period if the return on that stock market index falls below that minimum percentage. Thus, if stocks do well, you earn above-average returns on your annuity, and if stocks fall in value, you will not lose money (as you would with many variable annuities). One of the tradeoffs to an equity-indexed annuity is that the issuer will typically not pay you the full return on the equity index. Many equity-indexed annuities have caps (e.g., the most the issuer will pay you is 12 percent per year even if the equity index does much better than that). Furthermore, many issuers will pay you only a certain percentage of any given return in the equity index - called the participation rate. Assuming a 75 percent participation rate, if the equity index goes up 10 percent in a year, then the issuer may only credit your account with 7.5 percent for that period. Thus, with an equity-indexed annuity, you give up some of the upside potential for some protection on the downside.