There are two types of annuities. Fixed annuities provide you with returns at a pre-determined interest rate and the principal is guaranteed.* Variable annuities yield a return that varies with the success of the investments you choose, from among those made available by the insurance company under the variable annuity contract. Thus, the rate of return from a variable annuity may be higher or lower than a fixed annuity. In a variable annuity, your contributions are not guaranteed.
Fixed annuities are contracts that pay a fixed-rate interest for a set period. The issuing insurance company guarantees these annuities; thus, the advantage of fixed rate annuities is that they have lower risk and a predictable payout. On the other hand, inflation may erode the earning power of a fixed-rate instrument. Before you buy a fixed-rate annuity, be sure to check the financial health of the issuing company. Its ability to make good on your investment is crucial. Financial ratings of insurance companies are available from rating services such as Moody’s, A.M. Best and Standard & Poor’s.
Variable annuities have a two-tier structure: the annuity contract and the mutual fund investment options that are available through the annuity contract. Although the mutual fund investments in a variable annuity contract may have names, investment objectives, and management that are identical or similar to publicly available mutual funds, they are not those mutual funds. They most likely will not have the same performance experience as any publicly available mutual fund. Generally, the variable annuity contract will offer a range of investment or funding options from which you may choose. Your choices may include stock, bond, or money market funds.
Your principal and the return you earn are not guaranteed; they depend on the performance of the underlying investment options. If the investment options you choose for your annuity perform well, they may exceed the inflation rate or fixed annuity returns. If they don’t perform well, you may lose not only any earnings you’ve made, but even some of your principal.
Some variable annuities offer an option that guarantees both principal and interest, much like a fixed annuity. It is wise for you to use rating services such as Moody’s, A.M. Best and Standard & Poor’s to assess the financial strength of the issuing company.
*Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company.
