With a fixed annuity both your principal and your returns are guaranteed, meaning you know exactly how much money you will make when you buy it. An Indexed annuity is less conservative. Your principle is guaranteed with indexed annuities as well, however your returns will fluctuate depending on the market movements. A variable annuity is the most risky. With this type of annuity neither the returns or principal are guaranteed.
A fixed annuity is very similar to a Certificate of Deposit. When investing in a fixed annuity, the insurance company guarantees that the money invested in the annuity will grow at a pre-determined (fixed) interest rate, for a pre-determined number of years. In some cases, a fixed annuity will pay a super-high rate, (as much as 5% higher than market during the first year) and then drop down to a much lower rate during the sub-sequent years. Returns on Fixed Annuities tend to be a little higher than a comparable CD product of similar duration.
An indexed or Fixed Index annuity is like investing in a stock index mutual fund or stock index ETF. When investing in an indexed annuity, the insurance company provides you with a return on your investment that tracks the return of an index like the S&P 500 index. Your gains will go up and down with the index, however when the index rises you may not see the entire benefit. Almost always, Indexed annuities has a cap (a maximum) percentage gain. On the positive side, the annuity guarantees a minimum return regardless of the performance of the index. If the index goes down, you will never risk losing your principal investment, and a certain amount of gains. You can learn more about how indexed annuity performance is calculated here.
A variable annuity is like investing in a family of mutual funds. When investing in a variable annuity the insurance company gives you many different investment choices such as corporate bond, stock, money market funds (or technically called sub-accounts). You can put all your money in one choice or spread it out among several, and even change the allocation between sub-accounts at a later time. The performance of your annuity is directly connected to the performance of your investment choices meaning you can lose money if your investment choices don’t perform well.
This lesson is part of our Free Guide to Investing in Annuities. Continue to the next lesson here.
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