Annuities Part II: Different Types of Annuities
By: Suzanne Lako
The Henssler Financial Group Position Paper

In this article we describe the different types of annuities and summarize the features that make each type unique.

What are the different types of Annuities?
Annuities are classified as either immediate or deferred.

• Single Payment Immediate Annuity: This allows the annuitant to make a lump-sum contribution and then immediately begin receiving income that is guaranteed for life. Usually payouts can begin within the first 30 days.

Deferred Annuities
Deferred annuities allow for payouts to begin sometime in the future, therefore allowing tax-deferred growth on earnings. The main types of deferred annuities are as follows:

• Fixed Annuity: A fixed annuity guarantees fixed or pre-determined payments for a specific period, or for life, beginning at some future time. It is invested in fixed-income securities and cash. The insurer takes on both the investment risk and the mortality risk. Investment risk is the risk that the earnings in the annuity will not be enough to provide for the predetermined fixed payout. The mortality risk is the risk that the annuitant lives too long, i.e., the payments need to continue even when the money in the account has been depleted. These annuities guarantee a fixed interest rate for a specified period of time.
• Variable Annuity: Like a fixed annuity, a variable annuity defers taxes until withdrawal, or the annuity period; however, the money is invested in what is referred to as a separate (or sub) account that is selected by the investor. Sub-accounts consist of mutual funds, or an investment portfolio managed by investment managers. The value of the sub account will fluctuate with the performance of the underlying securities in the portfolio. Therefore, the payouts will not be fixed, but rather will be variable based on performance and growth of the separate account. The payout amount will always continue to depend on the performance of the portfolio. With a variable annuity, the investor takes on the investment risk since the performance of the securities in the portfolio is not guaranteed; however, income is guaranteed for life. Some examples of variable annuities are:
  • Periodic Payment Deferred: Allows the annuitant to make a series of payments into the annuity during the accumulation phase until the payout phase. This allows for earnings to accrue tax-deferred.
  • Single Payment Deferred: Allows the annuitant to make a lump-sum contribution to the annuity. This lump-sum will remain in the account and earnings will accrue tax-deferred until the payout phase.

Another type of annuity that needs to be mentioned is a Tax Sheltered Annuity.

Tax Sheltered Annuities
A tax-sheltered annuity (TSA) is a way for educators of public educational institutions and some nonprofit organizations to shelter and accumulate funds for retirement through payroll deduction. A TSA is also known as a 403(b). Some main characteristics of a TSA are as follows:

• Each payroll deduction, or contribution, into a TSA reduces your federal taxable income.
• Depending on the state, your state taxable income may also be reduced.
• Interest and capital gains are tax-deferred until you begin withdrawals.
• Social security and pension benefits are not affected by TSA benefits.
• You may contribute up to $15,500 in elective deferrals for 2008, with a $5,000 "catch-up" provision for those over age 50. For those with 15 years of service, there is an additional $3,000 service catch-up.
• You own and control all of the assets in your TSA. Generally, TSA's are fixed annuities or equity index annuities, and are guaranteed to earn a minimum interest rate.
• You may change your beneficiary at any time, and upon your death, your beneficiary will receive the TSA.
• As compared with other annuities, TSA's have less fees and in some cases no surrender charges.
• With TSA's there are no matching contributions. Because of this, we generally recommend to contribute to an IRA first and then to a TSA.
• You may withdraw from a TSA for a car, a child's education, or other types of loans. The borrowed money is tax-free, but you do have to repay the loan over a certain period of time.
• If you change employers, you may transfer, or continue the plan with the new employer (if eligible), leave the TSA as-is until retirement, or you may annuitize and begin receiving payments (of course, subject to early withdrawal penalties and fees).

For more information regarding this topic, please contact The Henssler Financial Group at 770-429-9166 or comments@henssler.com.