Ten facts about annuities

Whether an annuity fits your plan can depend on different factors, like how interest is credited, how taxes work, or when you can access your money.

Here are 10 facts about fixed index annuities.

 

 

An annuity is a contract with an insurance company  

 

In exchange for premium, the company provides a set of benefits described in the contract. Premium is the money you put into the annuity. Depending on the product, you may pay it as one lump sum, or as a series of payments over time.  

The type of annuity determines the timing. An immediate annuity begins paying within the first contract year. A deferred annuity pays at a future date and grows in the years before payments begin. How much your contract value grows depends on whether you own a fixed, fixed index, or variable annuity.  

 

 

Minimum premium varies by product 

 

Requirements differ by product and by insurance company, so there is no single-entry point. The more useful question is which contract matches the amount you have and the timeline you have in mind.  

The premium you pay is also your principal: the original amount in your contract, before any interest is credited. When you see the phrase "principal protection," it refers to that original amount.

 

 

A fixed index annuity protects your principal from market loss, and adds growth potential on top of that  

 

Take the protection first. Your principal is the premium you paid, not counting interest. A decline in the index does not reduce it — interest credited to a fixed index annuity is never less than zero, so a down year credits you nothing rather than taking something away.  

Credited interest works the same way from then on. Once interest is applied to your contract, it locks in, and a later index decline does not take it back.  

Growth comes next. Interest credits can be tied to the performance of an external index, such as the S&P 500® Index.  

Two limits to hold alongside that. The protection is from market loss specifically, not from every circumstance — withdrawals, surrender charges, and any rider fees can reduce your contract value, including interest you have already been credited. And minimum guaranteed values vary by product and state, so the amount available if you surrender early may be less than the premium you paid. Your contract states both. 

A traditional fixed annuity works differently. It credits a set interest rate guaranteed for a set period, which produces steady, predictable growth. A fixed index annuity typically has more growth potential, within limits: a cap is the maximum amount a fixed index annuity can be credited in a contract term, and a participation rate multiplies any positive change in the index to determine the interest credited.  

 

 

Not all annuities work the same way  

 

The word annuity covers products that behave differently, which is why the type matters more than the category.  

The clearest way to tell them apart is to ask one question: who carries the market risk?  

With a variable annuity, you do. You choose the portfolios your money goes into, so the value can rise or fall with the market. 

With a fixed annuity, the insurance company does. You are credited a set rate for a set period, regardless of what markets do.  

With a fixed index annuity, the company absorbs the index's down years — your interest credit is never less than zero — and in exchange, your growth in the up years has limits.  

That trade-off is the whole idea behind a fixed index annuity: protection from market loss in exchange for a ceiling on growth. Where the ceiling sits varies by contract, and it is one of the first things to ask about.  

Withdrawals, surrender charges, and any rider fees can still reduce your contract value.  

 

 

Annuities are available before retirement age  

 

Many annuities can be purchased well before you retire, though issue ages vary by product.

One consideration if you are buying early: if you withdraw money from an annuity before age 59½, you may owe an additional 10% federal tax on those funds.¹  

 

 

Interest in a fixed index annuity grows tax-deferred*  

 

You owe no income tax on credited interest until you take money out. Withdrawals are then taxed as ordinary income, and withdrawals before age 59½ may carry that additional 10% federal tax. Consider talking with a tax professional about how a withdrawal would affect your situation.  

*Assumes contract is individually owned.  

 

 

Your premium is not invested in the stock market  

 

A fixed index annuity is an insurance product, not a market investment.  

Interest is credited based on how an external equity or bond index performs, but your money is not directly exposed to that market, and credited interest is never less than zero. 

Access to your money depends on your contract terms  

 

Those terms are worth reading before you sign rather than after. 

An immediate annuity begins paying within the first contract year. With a deferred annuity, many contracts allow a free withdrawal of a set percentage of your contract value each year after the first contract year. Taking more than that during the surrender charge period can trigger a surrender charge, and withdrawals may be taxed as ordinary income.  

 

 

Annuities are regulated at the state level  

 

State insurance commissioners regulate annuities. Variable annuities carry additional federal oversight from the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority.²  

 

 

The right type depends on your goals

 

When you want payments to start, how much market exposure you are comfortable with, and how taxes fit into your income plan all shape which annuity makes sense.  

Bring these 10 facts to your next meeting with a financial professional and ask which type of annuity matches the retirement you have in mind.