Planning your financial future is a big deal, and when it comes to securing income for retirement, annuities are one of the most reliable options. But with so many types of annuities, how do you know which one is right for you? Don’t worry—we’ve got you covered!
In this guide, we’ll break down the different types of annuities, compare their features, and help you decide which option aligns best with your goals. Whether you’re seeking predictable income, long-term growth, or a balance between the two, this article will give you the clarity you need to make an informed decision.
If you’re new to annuities and want a general overview, check out our What Is an Annuity Guide.
What Is an Annuity?
An annuity is a financial product designed to grow your savings and turn them into steady income. It’s commonly used as a tool for retirement planning, helping individuals achieve financial security by providing guaranteed payouts. Here’s the key: annuities are highly customizable, so you can tailor them to your specific goals.
Annuities are generally categorized by:
- When payments begin: Immediate or Deferred Annuities
- How funds grow: Fixed, Indexed, or Variable Annuities
Let’s dive deeper into these categories and explore how they work.
Immediate vs. Deferred Annuities
The first distinction between annuities is when they start paying you. This can significantly affect how they fit into your financial plan.
Immediate Annuities: Income That Starts Right Away
With an immediate annuity, you begin receiving payments almost immediately—usually within one month of purchasing it. These are a great choice if you’re retiring soon and want a guaranteed paycheck.
Key Features:
- Funded with a one-time premium payment.
- Payments can last for a specific term (e.g., 10 years) or for life.
- Income is guaranteed and unaffected by market conditions.
Example: If you invest $300,000 in an immediate annuity, the insurance company might pay you $1,500 per month for the rest of your life. This provides peace of mind knowing your income is secure.
Scenario: Joan, a 65-year-old retiree, wanted to ensure she could cover her essential expenses like housing, groceries, and medical bills without worrying about market fluctuations. By purchasing an immediate annuity, Joan secured a steady monthly income that supplemented her Social Security benefits, giving her financial stability in retirement.
Deferred Annuities: Grow Now, Pay Later
If you’re still a few years away from retirement and want to grow your savings, a deferred annuity is a smart choice. With this option, your money grows during an accumulation phase, and you can start receiving payouts later—usually at retirement age.
Key Features:
- Flexible funding: Make one large payment or multiple smaller ones.
- Growth is tax-deferred, meaning you don’t pay taxes until you withdraw funds.
- Options to annuitize (convert into income) or withdraw savings.
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Example: You invest $150,000 in a deferred annuity at age 50. By age 65, your savings have grown to $250,000 tax-deferred. You can then choose to withdraw funds or convert the balance into guaranteed income.
Scenario: David, a 50-year-old small business owner, wanted to save for retirement without worrying about annual contribution limits like those on his IRA. A deferred annuity allowed him to grow his money tax-deferred while he continued working. At retirement, he converted the balance into income to fund his travel plans and leisure activities.
Deferred Income Annuities (DIAs)
A Deferred Income Annuity (DIA) offers a unique approach. Payments don’t start immediately but are guaranteed to begin at a future date. DIAs are perfect for people who want to secure income later while locking in today’s rates.
Key Features:
- Deferred start date (e.g., 5-10 years).
- Guaranteed income for life or a fixed term.
- Lower initial premium requirements than immediate annuities.
Example: If you’re 45 and invest $50,000 in a DIA, you might receive $5,000 annually starting at age 65, ensuring you’ll have a steady income during retirement.
Scenario: Sara, a 45-year-old professional, wanted to ensure she’d have a guaranteed income source starting at 65 to cover basic living expenses. A DIA gave her the confidence that her future self would have a secure, predictable income stream, complementing her other retirement accounts.
| Feature | Immediate Annuity | Deferred Annuity | Deferred Income Annuity (DIA) |
|---|---|---|---|
| When Payments Begin | Immediately after purchase | After an accumulation phase | At a pre-selected future date (e.g., 5-10 years later) |
| Funding | Single premium payment | Single or flexible payments | Single or flexible payments |
| Purpose | Provides immediate income | Focuses on long-term growth | Secures future income at guaranteed rates |
| Best For | Retirees needing income now | Pre-retirees planning for future income | Those locking in a future income stream today |
How Funds Grow: Fixed, Indexed, and Variable Annuities
Now that we’ve covered when payments begin, let’s talk about how your money grows. The growth mechanism determines how much risk and potential return you’ll have.
Fixed Annuities: Low Risk, Predictable Returns
With a fixed annuity, your funds grow at a guaranteed interest rate, making it ideal for conservative investors.
Key Features:
- Guaranteed returns with no market risk.
- Steady income payments during retirement.
- Simple and predictable.
Check out the latest rates in our Fixed Annuity Rates Marketplace.
Example: A fixed annuity with a 3% guaranteed annual return turns an initial investment of $100,000 into $134,392 over 10 years.
Scenario: Tom, a risk-averse saver, wanted to ensure he’d have a stable return on his savings without worrying about market volatility. A fixed annuity guaranteed his principal and offered predictable growth, helping him achieve his retirement savings goals with peace of mind.
Indexed Annuities: Growth With Downside Protection
Fixed indexed annuities tie growth to a market index, such as the S&P 500, offering higher returns while protecting your principal.
Key Features:
- Growth is linked to market performance but with a guaranteed minimum rate.
- No loss of principal if the market declines.
- Potential for better returns than fixed annuities.
Example: Jane invested $200,000 in an indexed annuity tied to the S&P 500. Over a five-year period, she saw her annuity grow by an average of 5% annually, with downside protection ensuring her principal was safe during market dips.
Scenario: Jane, a 55-year-old investor, wanted to enjoy market-linked growth without taking on the full risk of a downturn. The indexed annuity provided her with the potential for higher earnings while protecting her initial investment.
| Feature | Fixed Annuity | Indexed Annuity | Variable Annuity |
|---|---|---|---|
| Growth Mechanism | Fixed interest rate | Tied to a market index | Based on investments |
| Risk Level | Low | Moderate | High |
| Best For | Conservative savers | Balanced investors | Growth-focused investors |
Getting Income: Deferred Income Annuities vs. Indexed Annuities With Income Riders
When deciding how to structure your retirement income, understanding the nuances between Deferred Income Annuities (DIAs) and Indexed Annuities with Income Riders is critical. While both offer reliable income streams, they differ significantly in terms of ownership, access to funds, and how income is determined. Here’s a detailed breakdown to help you make the right choice.
How Does Income Work With a Deferred Income Annuity (DIA)?
A Deferred Income Annuity (DIA) is designed for simplicity. You pay a premium upfront (or over time), and the insurer guarantees a steady income starting at a predetermined future date. However, once you pay your premium, ownership of the funds transfers to the insurer.
- Guaranteed Income: The amount is fixed and predetermined when you purchase the annuity. It doesn’t depend on market performance, providing predictable and stable income.
- No Market Exposure: DIAs are not influenced by financial markets, making them an excellent choice for retirees prioritizing stability.
- No Access to Principal: After the premium is paid, you no longer have access to your funds. The tradeoff is long-term, guaranteed income security.
- Death Benefits: Optional death benefit riders may ensure your beneficiaries receive payouts if you pass away before or shortly after payments begin.
Example Scenario: At age 50, you invest $150,000 in a DIA, with payments starting at age 65. The insurer guarantees $10,000 annually for life. While you relinquish control over the $150,000, you gain peace of mind knowing exactly what you’ll receive and when.
How Does Income Work With an Indexed Annuity With an Income Rider?
An Indexed Annuity with an Income Rider provides more flexibility and control over your funds. The annuity grows based on the performance of a market index, such as the S&P 500, while the income rider guarantees payouts regardless of market conditions. Unlike a DIA, you retain ownership of your account value, allowing for greater adaptability.
- Growth Potential: Before activating the income rider, your account value grows based on market performance (subject to caps and floors).
- Flexible or Fixed Income:
- Income can be fixed and predetermined based on your contract, offering stability similar to a DIA.
- Alternatively, it can be flexible, allowing for potential increases if the market performs well, depending on the contract terms.
- Access to Principal: You retain ownership of your account value, meaning you can withdraw funds (subject to surrender charges during the surrender period).
- Death Benefits: Any remaining account value is often passed to your beneficiaries without requiring additional riders.
- Fees: Income riders typically involve annual fees that reduce the account’s growth potential, but they guarantee lifetime income.
Example Scenario: At age 55, you invest $200,000 in an indexed annuity with an income rider. By age 65, your account grows to $250,000. If the rider guarantees $12,000 annually for life, you may receive that fixed income. However, depending on your contract terms, if the index performs well, your income could increase over time.
Key Ownership and Income Differences
| Feature | Deferred Income Annuity (DIA) | Indexed Annuity with Income Rider |
|---|---|---|
| Income Guarantee | Fixed and predetermined | Can be fixed or flexible, with potential for higher income based on performance |
| Growth | No growth—purely for income | Market-linked growth with downside protection |
| Access to Principal | None after premium is paid | Full access to account value (with limits) |
| Ownership | Funds belong to the insurer after purchase | You retain ownership over the account value |
| Flexibility | Payments start at a fixed future date | You decide when to activate income |
| Death Benefits | Optional; may require an additional rider | Usually included without extra cost |
| Best For | Retirees wanting simple, guaranteed income | Those seeking flexibility and potential growth |
Which One Should You Choose?
Deferred Income Annuity (DIA): Best for individuals who value simplicity and a predictable income stream. Ideal for retirees who don’t need access to their principal and prefer the stability of a fixed payout.
Indexed Annuity with an Income Rider: Perfect for those who want a balance of growth potential and income security. Suited for people who value ownership of their funds and the option of fixed or flexible income with the potential for increases if the market performs well.
Both options can play an essential role in your retirement income strategy. To make the best choice, consider your financial goals, need for flexibility, and risk tolerance.
Need more guidance? Reach out to us at PlanEasy. We're happy to help.
FAQs About Annuities
What are the two types of annuities?
The two main types of annuities are immediate annuities and deferred annuities. Immediate annuities provide income right away, while deferred annuities grow your funds over time and pay out later.
What is the difference between fixed and variable annuities?
Fixed annuities offer guaranteed returns with no risk, making them ideal for conservative investors. Variable annuities, on the other hand, invest in portfolios like mutual funds, offering higher growth potential but with increased risk.
Are indexed annuities safe?
Yes, indexed annuities are considered safe because they protect your principal from market losses. While your growth is tied to a market index, you won’t lose money even if the market declines.
How do I choose the right annuity?
Your choice depends on your financial goals:
- Immediate income: Choose an Immediate Annuity.
- Long-term growth: Opt for a Deferred Annuity.
- Balanced growth and protection: Consider an Indexed Annuity.
- Higher risk and reward: Select a Variable Annuity.
Consulting with a financial advisor can also help tailor your choice to your unique needs.
Are annuities taxed?
Yes, annuity payouts are generally taxed as ordinary income. However, the tax treatment depends on whether your annuity is qualified (purchased with pre-tax dollars) or non-qualified (purchased with after-tax dollars). Qualified annuities defer taxes on contributions and earnings, while non-qualified annuities only tax earnings upon withdrawal.
What happens to an annuity when I die?
Most annuities include a death benefit, which means any remaining funds are paid out to your designated beneficiaries. Some annuities, like joint and survivor annuities, may continue payments to a spouse or other annuitant after your death.
What fees are associated with annuities?
Annuities can have several fees, including:
- Surrender charges: Fees for early withdrawal before the surrender period ends.
- Management fees: Associated with variable annuities for portfolio management.
- Rider fees: Additional costs for optional benefits, such as lifetime income guarantees.
Can I use an annuity for retirement income?
Yes, annuities are commonly used to supplement retirement income. Products like immediate annuities and deferred income annuities are specifically designed to provide consistent payments during retirement, ensuring you don’t outlive your savings.
About PlanEasy
PlanEasy was founded by financial industry veterans Michael Salem and Alex N.J. Choo. Our mission is to simplify retirement planning by providing transparent tools, expert advice, and competitive annuity rates.
Explore our Fixed Annuity Rates Marketplace to find options tailored to your financial goals, or learn more about how PlanEasy can guide your retirement journey.