Understanding Annuities

Radio Transcript, 2 minutes 30 seconds, for use during week of Nov. 4.

Announcer: Invest Wisely comes to you from Iowa State University Extension through a grant from the Investor Protection Trust, providing investor education on the web at: investorprotection.org.

Description: Penny, Susan and Ira talk about annuities.

Ira: Penny, the more I read about annuities, the more confused I am – Just what is an annuity?

Penny: An annuity is a contract between you and an insurance company.  In exchange for either a lump sum or a series of payments, the insurance company agrees to make regular payments for a fixed period of time, for your lifetime, or for the lifetime of you and your beneficiary.

Susan: Do the payments begin immediately or at some time in the future?

Penny: Annuities can be setup either way.  Typically, annuities offer tax-deferred growth of earnings.  In most cases they may also offer a death benefit which pays your beneficiary a guaranteed minimum amount, such as your total purchase payments.  Annuities are usually purchased for future retirement income.

Ira: Are all annuities basically the same? 

Penny: No -- There are three types of annuities--fixed, variable, and equity-indexed. 

Susan: How are they different? 

Penny: With a fixed annuity the insurance company guarantees a fixed rate of interest for a specified period of time, say, a period of 1 to 5 years after purchase.  After that the rate is adjusted annually according to market conditions.

Ira: And a variable annuity?

Penny: With a variable annuity, you select how you want to invest your money from a range of investment options, typically mutual funds.  The rate of return and the amount of the payments you receive vary depending on the performance of the investment options you select.

Susan: So fixed annuities offer a fixed rate of return for a certain period of time and a variable annuity has a rate of return that varies depending on the investment options.

Penny: Yes.  And equity-indexed annuities are more complicated.  This type of annuity pays a minimum guaranteed rate of interest, but that rate may be higher if the index to which it is linked increases.  Typically it is linked to the S&P 500 stock index. 

Ira: Thanks, Penny.  As usual, this is very helpful.

Penny: You’re welcome and remember for more information visit the ISU Extension website at extension.iastate.edu and look for ‘invest wisely.’