The Basics of Annuity Interest

By Compuquotes Team on January 19th, 2009

Money invested in an annuity accumulates as it earns interest. Annuity interest rates depend on the type of annuity. Before discussing the types of annuity based on the interest rates, it should be made clear that an annuity has two phases: the accumulation phase and the annuity phase. In the accumulation period, the invested money basically remains untouched as it is allowed to grow. The rate of increase of the account's value depends on the interest rate. In the annuity phase, which is also called the payout phase, regular payments start to be paid out to the annuitant (the one who receives the annuity).

In a fixed annuity, the invested money earns a fixed interest during the accumulation period. During the annuity period, the investment less the payout continues to accumulate at the fixed rate. Growth in a fixed rate will be relatively low but the investment is exposed to lesser risk. Investors in fixed annuity benefit best if the current interest rates fall but are on the losing end when they rise.

In a variable annuity, interest rates are dictated by market conditions. The money that you put into the annuity is allocated among different managed funds. You get to choose how to distribute your money into three types of funds - stocks, bonds and cash equivalents. The value of your account depends on the performance of your investment options.

Whether in a fixed or variable annuity, prevailing annuity interest rates are dictated by economic conditions. It is therefore not unusual for rates to change frequently and sometimes, significantly. Insurance providers regularly monitor the economic and financial market so they can adjust their interest rates accordingly.

If you're planning to purchase an annuity, try to shop around and compare interest rates. Be wary, however, of providers that offer high initial rates so as to attract clients but switch to lower rates after a certain period. Or, they may apply lower rates to subsequent contributions. That's why it is very important to understand everything about the annuity before you purchase it.

It is not so much the initial rates that matter as the long-term rate of return. With changing market conditions, however, this is especially difficult to foretell, especially with variable annuity. In this case, it would be sensible to look at the past performance of the funds where your money is to be invested. Basically, the performance of these funds also depends on how the insurance company and its fund managers handled them. So you might also want to check out if the company you're interested in has had proven accomplishment in the management of funds.

Apart from being able to manage funds well, the company should also be in the industry long enough and has a track record in annuities. This is because competitive annuity interest rates are also determined, aside from economic conditions, from experience. Those who have had experience in offering competitive interest rates that will benefit the contract owner and the annuitant, without jeopardizing the financial stability of the company is most likely able to come up with a favorable annuity contract.

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