What is an annuity?

With a deferred annuity, you pay one or more premiums over what is often called the accumulation period. The premiums you pay and any interest credited to your premiums go into a fund called an accumulation fund. There may be a minimum guaranteed interest rate at which your money will accumulate during the accumulation period.

The annuity payments you will receive begin at a future point in time called the maturity date. You will receive payments during the payout period or annuitization phase. You do not pay income taxes on the interest earned during the accumulation period unless you make withdrawals. Taxes are deferred until the payout period.

A fixed annuity provides fixed-dollar income payments backed by the guarantees in the contract. You cannot lose your investment once your income payments begin. The amount of those payments will not change. With fixed annuities, the company bears the investment risk.

During the accumulation phase of a fixed deferred annuity, premiums (less any applicable charges) earn interest at rates set by the company or in a way spelled out in the annuity contract. The company guarantees that it will pay no less than a minimum rate of interest. During the payout or annuitization phase, the amount of each income payment you receive is generally set when the payments start and does not change.

With an immediate annuity, you pay a single premium and immediately start receiving payments at the end of each payment period, usually monthly or annually.

These are a type of annuity, either immediate or deferred, that earns interest that is linked to an external equity index, such as Standard and Poor’s 500 (S&P 500) Composite Stock Index. When you purchase an equity-indexed annuity, you own an insurance contract—not shares of any stock or index.

An equity-indexed annuity is different from other fixed annuities because of the way it credits interest to your annuity’s value. Some fixed annuities only credit interest calculated at a rate set in the contract, while others credit rates set periodically by the insurance company. Equity- indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how the additional interest, if any, is calculated and credited. How much additional interest you get and when you get it depends on the features of your particular annuity.

Your equity-indexed annuity, like other fixed annuities, promises to pay a minimum interest rate. The rate applied will not be less than this guaranteed minimum, even if the index-linked interest rate is lower. Additionally, the value of your annuity will not drop below a guaranteed minimum. For example, many single premium annuity contracts guarantee the minimum value will never be less than 90 percent of the premium paid, plus at least 3% in annual interest (less any partial withdrawals). The guaranteed value is the minimum amount available during a term for withdrawals, as well as for some annuitizations and death benefits. The insurance company will adjust the value of the annuity at the end of each term to reflect any index increases.

Variable annuity investments are securities that fluctuate with market conditions. The value of a variable annuity depends upon the value of the underlying investment portfolios you choose, known as the insurer’s separate accounts. You, the owner or annuitant, bear the investment risk for the value of the security. The value of the annuity will increase or decrease with the investment performance of the security. The annuity’s value will decrease, with a poor investment performance. In fact, you can lose your investment!

A product receives the classification of a variable annuity if the value during either the accumulation phase or the payout phase depends on the value of the underlying security.

Some variable annuities provide a choice of either a variable payout or a fixed payout.

During the accumulation phase of a variable annuity, premiums (less any applicable charges) are put into a separate account held by the insurance company. You decide how those premiums will be invested by choosing from stock or bond mutual fund options. The value of the separate accounts, and therefore, the value of your variable annuity, varies with the investment experience of the funds you choose. There is no guarantee that you will receive your premiums back. There is also no guarantee that you will earn any return on your annuity. During the payout period of a variable annuity, the amount of each income payment you receive may be fixed (predetermined) or variable (changing with the value of the investments in the separate account).

With a tax-sheltered fixed or variable annuity, you defer income taxes on the interest earned until the payout period. You may also defer taxes on the income used to make premium payments until the funds are withdrawn. There may be a limit on the amount of income you can defer. These contracts, also known as “qualified” or “tax qualified,” must meet the conditions outlined by the Internal Revenue Service. A nonqualified annuity is a product in which premiums are paid with from after-tax dollars.