Last Updated: 1/9/2025
An annuity is an insurance contract sold by life insurance companies. Annuities can provide income for life, which makes them an important type of retirement income vehicle.
Overview: Insurers sell a variety of annuity products that differ in how they accumulate funds, get annuitized, and provide guarantees. Annuity premiums (also referred to as contributions) can be paid as a one-time lump sum payment or through a series of contributions that can differ by amount and timing, depending on the annuity contract. Single contribution policies are useful when the annuitant has a large lump sum of money, such as with an inheritance or lump sum retirement plan payout. Alternatively, flexible contribution policies are most suitable to consumers who want to accumulate retirement funds over time.
Annuities can be classified as either immediate or deferred.
- Immediate annuities are purchased with a one-time contribution and provide income payments to the annuitant within one year of purchasing the contract.
- Deferred annuities are purchased with either a single contribution or contributions made over time. The annuitant may elect to receive income payments that begin at some future date.
Annuities can also be classified as fixed, variable, or indexed.
- Fixed deferred annuity contracts guarantee a minimum credited interest rate. Contributions grow with interest during an accumulation phase, and the annuitant may later elect to annuitize the contract to receive a fixed income stream for a fixed period or for life. For immediate fixed annuity contracts, annuitants receive a fixed income stream based, in part, on the interest rate guarantee at the time of purchase.
- Variable annuity contracts allow the policy owner to allocate contributions into various subaccounts of a separate account based upon the risk appetite of the annuitant. The contributions can be invested in stock funds, bond funds, or other investments. Income payments in the annuitization phase can be fixed or fluctuate with the investment performance of the underlying subaccounts of the separate account. In contrast to fixed annuities’ guaranteed interest provision, policyholders assume the investment risk with variable annuities because they are separate account products that are valued at market every day. Variable annuities are registered as securities with the Securities and Exchange Commission (SEC). These annuities are often purchased with one or more guarantee provisions which limit the impact of negative investment performance for the policyholder’s investment selections. These guarantees could come in the form of policyholder minimum death benefits, guaranteed minimum period payments for a set period of time or until the annuitant’s death, and/or accumulation benefits.
- Indexed annuity contracts have both fixed and variable features. Under these policies, interest credits are linked to an external index of investments, such as bonds or the S&P 500, but contain a minimum guaranteed interest rate. Other recent market additions include the expansion of various product guarantees, similar to those offered in variable annuity contracts.
A notes that by the mid-1980s, growth in individual annuities had resulted in insurers' overall product mix becoming almost evenly distributed between annuity considerations and traditional insurance products. By the end of the century, annuity products had become so popular their sales volumes outpaced those of traditional life insurance. Low interest rates and equity market volatility of the post-2008 financial crisis era placed pressure on the returns and hurt insurers' ability to support variable annuities, many of which were issued with minimum guarantees. Insurers responded by reducing their guarantees. For fixed deferred annuities, credited interest rates were reduced. Interest rates began to rebound in 2021 fixed and variable annuities continue to be in demand, particularly as aging consumers seek savings vehicles designed to help them manage their long-term needs.
