Written By: Josh Garland, ChFC® | FPG | 877.455.0119
An annuity is a contractual agreement between a consumer and an insurance company that will provide a set of benefits depending upon the type of annuity contract that is selected. The benefits are most commonly in the form of a guaranteed stream of income, the opportunity to earn interest or both. The interest that is earned within an annuity contract will grow tax deferred and upon death, the death benefit will go directly to the designated beneficiary, avoiding probate.
What types of annuity contracts are there?
There are four distinct types of annuity contracts, Single Premium Immediate Annuities (SPIA), Deferred Income Annuities (DIA), Single Premium Deferred Annuities (SPDA) and Flexible Premium Deferred Annuities (FPDA). Both SPDAs and FPDAs can then be further broken down into sub-categories which are Fixed Annuities, Fixed Index Annuities and Variable Annuities.
A Single Premium Immediate Annuity (SPIA) is an annuity contract that in exchange for a single premium payment will begin distributing an immediate stream of income to the designated payee of the contract. Note that no additional premium contributions will permitted after the policy is issued. An immediate stream of income means that payments will begin within a period of no more than 12 month from the issue date of the contract. The consumer will normally have multiple income benefit choices for how they would like to receive their income benefit payments.
- Life Only: Payments are paid only if the Annuitant is living and upon death of the Annuitant, annuity payments stop and no further benefits are payable.
- Life with Period Certain: Payments are paid if the Annuitant is living. If the Annuitant dies before the elected period certain has been completed, annuity payments will continue to be paid to the beneficiary as scheduled until the period certain has ended; at which time annuity payments will stop and no further benefits are payable.
- Life with Installment Refund: Payments are paid if the Annuitant is living. If the Annuitant dies before the sum of annuity payments paid equals or exceeds the single premium, annuity payments will continue to be paid to the beneficiary as scheduled, until the sum of all annuity payments paid equals the single premium; at which time annuity payments stop and no further benefits are payable.
- Life with Cash Refund: Payments are paid if the Annuitant is living. If the Annuitant dies before the sum of annuity payments paid equals or exceeds the single premium, a lump sum death benefit equal to the premium paid less the sum of all prior annuity payments will be paid to the beneficiary, at which time annuity payments stop and no further benefits are payable.
- Period Certain: Annuity payments will be made for the elected period certain. If the annuitant dies prior to the end of the period certain payments will continue to be paid to the beneficiary as scheduled until the remained of the period certain has ended. Once the period certain has ended annuity payments will stop and no further benefits are payable. (Note payments will stop even if the Annuitant is still alive.)
A Deferred Income Annuity (DIA) is an annuity contract that works very much like a SPIA. The key difference between a SPIA & DIA is that the income distributions from a DIA will start at an elected date sometime after 12 months from the issue date. The consumer will elect the income start date at the time of contract and will also have income benefit choices like those of a SPIA although they will be limited to:
- Life Only
- Life with Cash Refund
Note that with a SPIA or a DIA the income benefit election can be based on either a single or joint life. Additionally, it is prudent at this time to note that this process of exchanging a premium payment for a guaranteed stream of income such as those provided by a SPIA or DIA is called “Annuitization.”
A Single Premium Deferred Annuity (SPDA) is an annuity contract that in exchange for a single premium payment will provide interest credits to the principal value of the contract for a specified period of time. As implied by the name this type of contract will only allow one premium payment and will not accept additional contributions. The way that interest is credited to the contract will depend upon which of sub-categories of SPDAs has been chosen.
- Fixed Annuity: A fixed annuity will credit a fixed rate of interest that does not fluctuate to the annuity contract each year. Fixed annuities can be further broken down into 2 sub-categories:
- Traditional Fixed Annuities will have a guaranteed fixed rate for a specified time period, say 1 year for example, that is declared by the insurance company at policy issue and will then renew the rate each year on contract anniversary date thereafter. The rate could then increase or decrease, but will not go below a declared minimum guaranteed rate that is set by the insurance company at policy issue.
- Multi-Year Guaranteed Annuities (MYGA) will have a guaranteed fixed rate that is locked in and does not fluctuate for the duration of the annuities term. This term is chosen at policy is and is also known as a surrender period. Generally, a longer term will offer a higher fixed interest rate than a shorter term.
- Fixed Index Annuity: A fixed index annuity will credit interest to the contract based on the performance of a market index, commonly the S&P 500 Index. These contracts will allow the contract owner to participate in gains of the market index up to a limited amount while at the same time protecting the value of the contract if the market index performance is negative.
- Variable Annuity: A variable annuity will credit interest to a contract based on the performance of its sub-accounts which are similar to mutual funds. The sub-account options will allow the contract owner to have unlimited market exposure to the full gains or losses of the stock market via the elected sub-accounts.
A Flexible Premium Deferred Annuity (FPDA) is an annuity contract that works that same as an SPDA having the same sub-category annuity options, however these policies will allow for additional contributions in future years.
Disclosure: The content of this article is for informational purposes only. All information or ideas provided should be discussed in detail with a licensed insurance agent, advisor, accountant or legal counsel prior to implementation.