Insurance companies issue annuity to accept and grow the funds of the policyholders. In this type of life insurance, a stream of payments or income will be created upon annuitization and the money that the policyholder pay in can either be a number of payments or a lump sum. Generally, these contributions earn a tax-deferred rate of return.
Types of Annuities
Annuities are mainly categorized into two ways: immediate vs. deferred annuities and fixed vs. variable annuities. The former has everything to do with every income payout that begins while the latter has to do with how a policyholder invests his contributions.
Immediate Annuity vs. Deferred Annuity
On one hand, an immediate annuity ensures that the money invested by the policyholder will provide guaranteed return as soon as he makes his initial payment. Depending on the status of the annuity (either tax- or non-tax-qualified), a part of or the total payment can be incorporated into the taxable income of the policyholder. The insurance owner can choose to receive either guaranteed payments for life or over a specific period of time.
On the other hand, the conditions in a deferred annuity include payments being put off for a specific period of time to allow investments yield generally tax-deferred interests. The policy owner has the freedom to choose when he wants to start receiving his income payments, which could be typically upon retirement.
Fixed Annuity vs. Variable Annuity
For policyholders who has a Fixed Annuity, their insurance company basically places their money in high-quality fixed-rate investments like bonds, and the company earns a fixed-rate interest for a specified period of time. The insurance company then guarantees the policyholder a minimum interest rate that he can earn often during a definite period. With this type of life insurance, it is the insurance company that is generally taking the risk, not the policy owner.
While for policyholders covered with a Variable Annuity, their money is allocated to market-based investments such as stocks, money markets, bonds, or mutual funds and the owner may choose to place his money around these investments. Additionally, the return rate may vary depending on the performance of a specific investment. Unlike the fixed annuity where the insurance company is taking the risk, the variable annuitant becomes the risk-taker.