A lot is said in the media today about annuities. Advertisers, proponents, critics and consumers discuss different aspects of these instruments, leading to great confusion. Here is some basic information about annuities.
In the dictionary, an annuity is a periodic payment. A life annuity is a contract issued only by a life-insurance company. It is sort of the reverse of a life-insurance policy. With life insurance, you make periodic payments (premiums) in order to get for beneficiaries a lump-sum payment (death benefit) when the Grim Reaper arrives. With a life annuity, you pay the insurer a lump sum and get in return a series of periodic payments which can be guaranteed for life or for two lives (joint annuity) or possibly longer.
One can also use an annuity to accumulate that lump sum for later lifetime payback. If one makes a series of payments into an annuity, it is called an "installment-premium deferred" annuity. If one puts in just a single lump sum and intends a future draw from it, it is referred to as a "single-premium deferred" annuity ("SPDA" in many ads). If a single payment creates an immediate lifetime payout, it is called a "single premium immediate" annuity.
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An annuity can be a "fixed" annuity, which means that the insurer guarantees the safety of the cash value in the policy as well as at least a minimum interest rate. A discussion of the alternative, the "variable" annuity, is beyond the scope of this article.
In recent years, the insurance industry has created the equity-indexed annuity. This is a fixed annuity that wants to be more. That is, while it does not invest in securities, it guarantees to credit interest linked to the performance of an equity index, usually the Standard and Poor's 500 Index. It guarantees the principal and at least a low annual return over a certain term. But it further guarantees to credit additional interest equivalent to at least part of the growth (or reflect the loss) of that equity index in each period, such as a year. Because of certain built-in limitations, the amount credited is usually not as great as the full growth of the index.
In some circumstances, the equity-indexed annuity is attractive. But all its moving parts require diligent inspection and full understanding before purchase.
J. Brendan Ryan is a Walnut Hills insurance agent.
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