This is a great question because there is often a lot of confusion when individuals first start considering the purchase of an annuity. There are three different types of annuities.
1. Traditional or Immediate Annuity
The first and oldest type of annuity is a fixed annuity sometimes called a “traditional” or “immediate” annuity. In its most basic form, it resembles a classic pension.
2. Indexed Annuity
The second type of annuity is an indexed annuity. An indexed annuity offers the potential to make more than the specified minimum interest rate for the product purchased because it is tied to a stock index such as the S&P 500 Composite Stock Price Index. If the Index goes up, the purchaser can earn more than the minimum rate contracted for, but there is a maximum percentage allowed, however. If the Index goes down, the purchaser still gets the minimum rate of return agreed upon.
3. Variable Annuity
Lastly there is the variable annuity. This product is generally reserved for an individual with a higher risk tolerance, as the lump sum or periodic payments are invested directly in the stock market. There is normally no minimum interest rate guarantee as the purchaser is responsible for choosing the options.
However, many variable annuity products allow an individual to place a portion of the investment earnings in a fixed minimum interest rate account held within the annuity. Because the investment options for a variable annuity are typically mutual funds that invest in stocks, bonds, and money market instruments, variable annuities are regulated by the SEC (Securities and Exchange Commission).