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There are two basic types of annuities with a lot of derivations: fixed and variable annuities. Fixed annuities offer a guaranteed rate of return for a specified term, usually a year. The rate adjusts based on interest rate conditions, most often on an annual basis. These are secure accounts with a stable return.
Variable annuities are accounts that offer equities sub-accounts for investors to seek growth and higher returns. These accounts fluctuate and can lead to loss of principal. Variations include index annuities tied into market indexes, or minimum rate annuities that offer a lower rate on sub-accounts to guarantee a minimum rate of return. -
As mentioned before, an annuity's rate of return is dependent on what type of annuity it is and how the return is determined. Fixed annuities often offer a bonus rate in the first year to sign up for the annuity, and then go with competitive annual rates from there. These rates are often similar or slightly higher than time certificates for a twelve-month period.
Variable annuity rates will depend on the investments you choose for your account. You can use conservative bond funds or go with growth and income funds investing in large capitalization stocks. There are often more aggressive small cap stock funds or international funds as well. Your return will fluctuate the same as it would in any mutual fund. -
All annuities have fees that pay for the cost of doing business, marketing and any guarantees the annuities offer. Fixed annuities don't publicize this rate, since the fixed rate you are given has already taken into consideration the company fees associated with the account. Your return therefore is a true return.
Variable annuities use mutual fund sub-accounts. Mutual funds have management fees associated with them. Additionally, there are fees taken annually for the maintenance of the variable annuity. You should confirm whether or not the return you see on your statement is before or after any fees. Obviously, these fees will lessen the rate of return, especially if you are comparing it to the same fund not held in an annuity. - If you pull money out of an annuity prior to the term period, you will pay a surrender charge. Surrender charges are a percentage of the money pulled out. Fixed annuities often don't allow surrender charges to eat into principal, but they can erase all earnings if you pull it out for emergency use. There is usually a 10 percent allotted annual withdrawal that has no penalty on most annuities, fixed or variable. The surrender charge generally starts at a higher rate in the early years and is reduced for every year the annuity is held. For example, a seven-year annuity may have declining surrender charges, starting at seven percent, then six percent and so on.
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Taxes are a two-way street with annuities. The fact that you don't pay taxes on money earned in the account is a very positive thing that increases your return by your tax rate or capital gain rate. So, a time certificate offering the same rate that is taxable annually is really a lower return since you will not have to pay taxes on the money in the annuity. This is very important with variable annuities.
When money is withdrawn, you will pay taxes, but this is an income. Therefore, capital gains is mitigated. The money saved in taxes over the years of the investment more than pays for itself when you do pull the money out.
