Plain English summary of annuities

I could write a whole book about annuities and still not cover everything there is to know. Nonetheless, I wanted to provide a summary of the major types and features of annuities to explain what they are and how they function.

There are three main annuity types:

Fixed – You give an insurance company a lump sum of money. In return, they give you a guaranteed fixed payment every month.
Variable – You invest a lump sum of money through an insurance company. In return, they give you a payment every month. However, unlike a Fixed annuity, the payment from a Variable annuity is based on the value of the money you invested. If your investments increase in value, your payment goes up. If your investments decrease in value, your payment goes down.
Indexed – You give an insurance company a lump sum of money. In return, they give you a guaranteed minimum payment every month. The payment may be higher than the minimum if a pre-determined financial market index - such as the S&P 500 - is above a certain level.

For each of these three annuity types, you can select how long you want the payments to last. Typically, most people choose to have payments last until they die, or until both they and their spouse die. Alternatively, you can choose to have payments last only for a certain amount of time, such as 10 years.

You can also select when you want payments to start. The two main payment start options are:

Immediate – Payments start no later than 12 months from the date you buy the annuity.
Deferred – Payments start later than 12 months from the date you buy the annuity.

In addition to combining the various payout types, payment lengths and payment start options, there are also various bells and whistles - or “riders” - which can be added. For example, you can add in a feature which guarantees the return of your initial investment if you die before a certain age, or one which guarantees you a minimum amount of payments during your life (in the case of a Variable annuity).