Types of annuities explained: fixed, indexed, variable, immediate, and deferred

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An annuity is an insurance product. You pay the insurance company, in one payment or over time. In return, the company promises to pay you income, either for a set number of years or for the rest of your life.

Most annuities have two phases. In the first phase, your money grows. This is called the accumulation phase. In the second phase, the company pays you. This is called the payout phase.

An annuity is not a bank account. The FDIC does not insure it. The promise is only as good as the company that makes it. If the company fails, a state guaranty fund may cover part of what you are owed.

Annuities are sorted two ways. The first is how your money grows: fixed, indexed, or variable. The second is when income starts: right away (immediate) or later (deferred).

So every annuity is a mix of the two. A "deferred fixed annuity" grows at a set rate, then pays you later. An "immediate variable annuity" starts paying soon, and the amount can change with the market.

Fixed annuity. The company sets the interest rate. The rate may be locked for some years, then change. The market cannot lower your account. A multi-year guaranteed annuity (MYGA) is a fixed annuity that locks one rate for a set number of years.

Fixed indexed annuity. Your growth is tied to a market index, such as the S&P 500. You get part of the index's gain, not all of it. A cap sets the most you can earn. A participation rate sets the share you get. For example, with a 75% participation rate and a 10% index gain, you get 7.5%. Gains usually leave out stock dividends. Your money is generally protected from market drops.

RILA (registered index-linked annuity). This is also tied to an index, but you can lose money. A buffer takes the first part of a loss. For example, with a 10% buffer and a 15% index drop, you lose 5%. A floor sets the most you can lose. Some people call these buffer or structured annuities.

Variable annuity. You put your money in funds you pick, a lot like mutual funds. Your account goes up and down with the market. You can lose money. Fees are often higher. The SEC says one fee, the mortality and expense charge, is often about 1.25% a year.

Every annuity is overseen by your state insurance department. Variable annuities and RILAs are also securities, so the SEC and FINRA oversee them too. For a closer look at one type, see fixed annuities explained.

An immediate annuity starts paying you right away or soon after you buy it. You pay one lump sum. The IRS treats it as immediate if payments start within one year. People use it to turn savings into a steady check.

A deferred annuity grows first and pays you later. You can pay in once or over many years. You do not owe tax on the growth until you take money out.

When you are ready for income, you pick how the company pays you. Turning your account into a stream of payments is called annuitizing. FINRA warns that this choice is generally final.

• Life only: pays for the rest of your life. It stops when you die.
• Life with period certain: pays for life, and also for at least a set time, such as 10 years.
• Joint and survivor: pays as long as you or a second person lives.
• Period certain: pays for a set number of years, such as 10, 15, or 20.
• Fixed amount: you choose how much you get each month. The money may run out.
• Lump sum: you take it all at once. You pay tax on the earnings all in one year.

A surrender charge is a fee for taking money out early. It is highest in the first years. Then it goes down each year until it ends. The SEC says it often lasts 6 to 8 years, and sometimes 10. For indexed annuities, it can last 6 to 10 years or longer.

Most contracts let you take out a small part each year with no charge. Ask how much. Swapping one annuity for another can start a new surrender period, so be careful if someone urges you to switch.

The free look period is your chance to change your mind. After you buy, you can cancel within a set number of days with no surrender charge.

Taxes depend on how you paid for the annuity.

Qualified annuity: bought inside a retirement account, like a traditional IRA or 401(k), with money you have not paid tax on. All of what you take out is taxed as income.

Nonqualified annuity: bought with money you already paid tax on. Only the earnings are taxed. With regular payments, the IRS lets you count part of each payment as your own money back, tax free.

Annuity earnings are taxed as ordinary income, not at the lower capital gains rate. The details are in IRS Publication 575. A tax advisor can help with your own case.

Annuities can do one thing few other products can. They can pay you as long as you live. That is the main reason people buy them.

But FINRA warns that annuities "are complex and can be costly." Variable annuities are a leading source of investor complaints to FINRA. That is why some people say to avoid them. The fix is not to fear annuities. It is to know the costs and the limits before you sign.

Two annuities with the same name can work in very different ways. Read the contract, and the prospectus if it is a variable annuity or a RILA. Use this list to compare.

Be wary of fancy titles. The NAIC warns that titles like "senior adviser" do not always mean special training. If you think you were misled, call your state insurance department.

Life insurance and annuities protect against opposite risks. Life insurance pays if you die too soon. An annuity pays if you live a long time. Some people use both.

They are taxed differently at death. A life insurance death benefit is usually not taxed as income. When an annuity pays your heirs, they usually owe income tax on the earnings part.

To learn more, start with life insurance explained.