Definition:

A contract that provides for a series of payments to be made or received at regular intervals. There are many kinds of annuities. *©LOMA Glossary of Insurance Terms

Why Annuities?

An annuity is a contract between you and your insurance company that says you will deposit a certain amount of money and, in return, the insurer will make payments to you at a time agreed upon in the contract.

The insurer invests your money in various fund portfolios and based on their performance, the cash value builds with interest growing on a tax-deferred basis. At the time specified in your contract, you receive payments from the account.

There are three main types of annuities which differ in how the money in your contract is invested.

• Fixed annuity. The money you invest earns a fixed rate of interest that is guaranteed by the insurance company. When you annuitize, your payments are also fixed. While this minimizes risk it also eliminates any gains you could make if the stock market performs well.

• Variable annuity. Your money is placed in investment options called subaccounts, which are similar to mutual funds. Each subaccount has its own degree of risk, ranging from aggressive growth funds to bond funds. The subaccount investments which you select, ultimately determines your benefits. When you annuitize, your payments fluctuate depending on the performance of your investments. Some variable annuities allow "fixed annuitization," in which you receive fixed payments. The insurance or investment company recalculates your fixed payments each year based on the performance of your investments.

• Equity-indexed annuity. Your money is invested in a fixed account and you may earn additional interest based on the performance of a particular stock index, such as the Standard & Poor's 500 Index, the Dow Jones Industrial Average or the NASDAQ Composite Index. This provides a balance between fixed and variable annuities -- opportunity to earn money based on stock performance and the stability of a fixed account. When you annuitize, your payments are usually fixed.

Before buying an annuity, consider:

• Since interest grows tax-deferred in an annuity, your money will grow more quickly than with a taxable account.

• Investors may owe income tax and a 10% federal tax on all money withdrawn before age 59½, so your financial benefit is greater if you postpone withdrawals until you reach age 59½.

• Many annuities serve as a form of retirement income as they can guarantee a lifetime income stream of regular payments after the age of 59½. However, this guarantee is backed by the insurance company you choose. Therefore, the ethical standing and financial strength of the company offering the annuity are important.

Tips on Buying Annuities

• Check with your state's insurance department to make sure the company is licensed in your state.

• Be sure the company is reputable. A good place to start is to look for the IMSA logo. The IMSA logo can be displayed only by an insurance company that has been successfully measured against IMSA's Principles and Code of Ethical Market Conduct.

• Be sure the company is financially strong. Many independent services rate the financial strength of insurance companies, such as A.M. Best Company, Fitch Ratings, Inc., Moody's Investor Services Inc. and Standard & Poor's Insurance Rating Services.

• Review all of your other savings plans, pensions or other retirement funds to determine whether you need an annuity. Is there a possibility that you could outlive your assets?

• Determine whether you want your investment to be steady and fixed or variable in hopes of capitalizing on market highs.

IMSA Member Companies

To locate an IMSA member insurance company, click here.