So just how do annuities work? Let us guide you through the basics so you understand what they are.
Annuities are nothing more than a contract between you and an insurance company. You purchase certain guarantees and promises, and pay for those guarantees with premiums to the company.
The insurance company in turn invests your paid in premium, and because of the tax rules governing insurance companies, the money grows tax-deferred. The company commits to pay you either a lump sum, or a stream of income, at some future date from the funds you have invested with them- your premiums.
The specifics of how and when your money comes back to you are all laid out in the contract in the beginning.
Annuities represent insurance for your money- your money joins billions of other dollars managed by the insurance company, and is professionally and conservatively managed and grown by the insurance company- something they do quite well.
But the key thing is that, unlike an investment account or 401K, the insurance company GUARANTEES certain performance and appreciation amounts in your contract- and their own capital and credit backs that up. This is another thing insurance companies are known for- stability and strength.
With annuities, depending on the terms of your contract you lay off the risk of loss, and reap the rewards of peace of mind that comes with knowing your money is growing safely, and is guaranteed, insured, and protected…. And NOT subject to political whims!
Interest Rates On Annuities
Too often, people focus on the annuity rates, and not on the fact that you are buying insurance first and foremost. But it is a fact of life and we should discuss annuity rates early on.
There are four key interest rate components in an annuity contract. Knowing these rates will help you understand annuities better:
1) Base Guaranteed Rate: This is the contractual minimum rate that the annuity will yield. This rate will range from 1-3.5% except in the case of a CD-Type Annuity, which will lock a higher rate for the life of the contract.
2) Current Rate: Each year an insurance company will declare a rate to be applied to in-force contracts. It’s a function of current market and is competitive among carriers- This keeps competition alive in the insurance industry.
3) Bonus Rate: Many contracts inject a bonus rate as an additional teaser for new customers. Certain annuities offer excessively high bonuses. Several factors need to be considered in regards to bonus rates, and it’s important to focus on what is important here- strength and stability of the company. Generally, great companies don’t need to bribe you with bonuses to get your business.
4) Yield to Surrender: This represents the effective rate of return projected throughout the contract time period. It is also the single most important interest rate to consider.
Types of Annuities:
There are two main categories of Annuities, based on the timing of payments to you and on the appreciation rate on your money.
Fixed Annuities are the simplest annuities to understand- they grow at a fixed rate and are an appropriate place for safe money.
Variable Annuities fluctuate up AND DOWN based on stock and bond portfolio allocations that you select.
Index Annuities- (which can be termed Equity Index Annuities as well as Fixed Index Annuities)- tie their appreciation rate to a market index that you have some participation in but do NOT have exposure to market downside risk.
We make it sound simple, right? Well there are millions of ways to complicate even the most straightforward concept, and annuities are no exception. We cut to the chase and help you understand annuities in The Annuity Report.
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