Annuity Phases

There are two distinct phases in an annuity. The first phase is the accumulation phase when the individual is making contribution to the annuity plan and the annuity account is building up. In case of immediate annuity plan, the accumulation phase overlaps with the pay out phase, the second phase of annuity, when income to the annuity holder begins. In deferred annuity plans, the accumulation phase and the payout phase overlap for a certain period of time depending on the time of start of payment.

Annuity can be paid either in a lump sum way or at a regular interval. The earnings from the annuity investments can be fixed or variable or linked to the performance of a stock market index. In the case of the index linked annuity plans, which are similar to fixed income annuity plans, the annuity is linked to an index, though the benefits from the index do not translate on a one-to-one basis from the index growth to the annuity earnings. The annuity earnings are calculated based on a formula linking the annuity return to the index growth and the annuity earnings are a certain percentage of the index growth. There are a number of differences among each of these plans, but they all fall into three broad categories. These differ in the way the index growth is calculated and the annuity earnings are linked to them.

If the annuity is of variable type, there are two types of accounts maintained in the annuity. One is the fixed account and the other is the variable account. In the fixed account, the principal amount as well as the interest amount is guaranteed for a certain period, usually one year. However, in certain plans this period can even be longer. In the variable account, the investment risk is borne by the annuity owner. The individual can specify as to how much money should be invested in which option, as for example 20% to stock market, 50% to bond, or he may choose different percentages based on his risk and return expectation. He also has the option to choose the stocks in which to invest. The return will depend upon the performance of the options he has opted for during the period under consideration.

There is also an option for transfer of investment alternatives. One may transfer the money from one investment alternative to another. This can be done at any stage even after the start of the plan to enable the investor to take advantage of movements in the stock market or the interest rate movements. For example if the stock market is buoyant, the investor can take advantage of the situation and choose to have more percentage of stocks in his plan. Similarly interest rate movements in the market can also be taken advantage of by changing the profile of fixed income security or bond component in the plan. In this one does not have to pay on the income from invested money, though, insurance company may charge some amount of transfer fee. Some tax liability is also created if this option is exercised.