An annuity is a contract between you (the purchaser or owner) and an insurance company. In its simplest form, you pay money to the annuity, the issuer invests the money for you, and then the issuer pays out the principal and earnings back to you or to a named beneficiary. The contractual guaranteeds depend on the financial strength of the issuing insurance company.

There are many different annuity types--enough to boggle the mind of anyone at first glance. Furthermore, the companies that issue annuities are busy creating new types of annuities every day to meet the changing needs of consumers. However, when all the different types of annuities are clustered together, it is easy to see that most differ on just a few important variables.

Generally speaking annuities fall into three broad categories.

A Fixed Annuity pays a fixed, set rate of interest, which could change periodically, on the money invested in the annuity.

A Variable Annuity allows you to invest your annuity money in one or more investment subaccounts, which invest in stocks, bonds, money market instruments, and other types of investments. With a variable annuity, the amount of earnings that will be credited to your annuity account will depend on the performance of the underlying subaccounts. Unlike a fixed annuity, you assume the investment risk on the annuity.

 A third  type of annuity is an Equity-Indexed Annuity, a sort of a hybrid between a fixed annuity and a variable annuity. When you purchase an equity-indexed annuity, the issuer agrees to pay a return on your account that is tied to a stock market index. However, the issuer also guarantees to pay you no less than a certain return in a given period if the return on that stock market index falls below that minimum percentage.

Annuities offer many attractive advantages such as tax-deferal of the earnings (i.e., the interest earned on your money). Also annuities may offer a number or riders, such as guaranteed annual lifetime payments and utilization for long term care.

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