How Well Do You Know... Annuities?

While lots of people are clueless about annuities, these retirement products are something you likely will need to get comfortable with. As old-fashioned pension plans play a smaller role in people's retirement, annuities are expected to play a bigger one.

This quiz tests your knowledge of their basics, plus some of the newest twists.

1) True or false: An annuity provides protection that can be viewed as the opposite of life insurance.

ANSWER: True. With an annuity, you hand a sum of money to an insurance company and can receive -- either immediately or commencing in the future -- a stream of payments for your lifetime.

That makes an annuity like life insurance in reverse, according to NAVA Inc., an association of companies involved in the annuity industry. "Whereas life insurance protects an individual against premature death, an annuity protects an individual who lives a long life from running out of money," a NAVA fact book says.

2) When did the first annuity come into existence?

A. Early Roman times
B. 1759, offered by a Pennsylvania company to Presbyterian ministers and their families
C. 1868, in Britain
D. 1930s, as part of New Deal programs to provide for people's retirements

ANSWER: A. Citizens would make a one-time payment to a contract known as an annua in exchange for income payments received once a year for the rest of their lives, NAVA says.

3) What do you call an annuity that starts providing regular income checks shortly after you purchase it?

A. Immediate annuity
B. Payout annuity
C. Income annuity
D. All of the above

ANSWER: D. These are three common names for this type of contract. According to ImmediateAnnuities.com, $100,000 currently buys about $6,875 of annual income for a 60-year-old couple, paying until the widow or widower dies.

4) True or false: A deferred variable annuity is akin to an individual retirement account invested in mutual funds.

ANSWER: True, though a key difference is that there is no upfront tax deduction with the annuity, as many people get from an IRA. Like an IRA, a "deferred" annuity lets your money grow with tax deferred on the earnings; "variable" means you get to spread your money among mutual-fund-like investment portfolios, generally known as subaccounts.

Note: Total expenses for a variable annuity run about one percentage point more than those of mutual funds. One reason is that many annuities promise a guaranteed minimum "death benefit" for the owners' heirs.

In retirement, many variable-annuity owners either draw out their money or swap it for a lifetime stream of income (so-called annuitization). Increasingly, insurers have added "living benefit" riders, at extra cost, such as ones promising minimum investment returns to those using the products for retirement income. People in annuities with these guarantees may be sleeping better these days than those in mutual funds, given the stock market's plummet. (Meanwhile, the cost of making good on the guarantees has contributed to steep drops in many insurers' stock prices.)

5) When was the first variable annuity sold in the U.S.?

A. 1932
B. 1942
C. 1952
D. 1962

ANSWER: C, by Teachers Insurance & Annuity Association, which began in 1918 as a pension fund for college educators, holding government, railroad and industrial bonds that weathered the Great Depression. In the face of lengthening life expectancies, a TIAA task force in 1950-51 examined markets dating back to 1880 and concluded that investing retirement money solely in fixed-income instruments was unwise because of inflation risk. So TIAA created College Retirement Equities Fund, the nation's first variable annuity, to complement its TIAA products.

6) Of the "guaranteed minimum" benefits, which is most commonly offered on deferred variable annuities?

A. Guaranteed minimum income benefits
B. Guaranteed minimum accumulation benefits
C. Guaranteed minimum withdrawal benefits
D. Guaranteed lifetime withdrawal benefits

ANSWER: C, according to NAVA. About two-thirds of contracts offer some form of this. In general, this benefit promises that a certain percentage -- usually 5% to 7% -- of the amount invested can be withdrawn annually until the entire amount is completely recovered, regardless of market performance. If the underlying investments perform well, there will be an excess amount in the policy at the end of the withdrawal period. The cost typically ranges from 0.35% to 0.75% of the amount invested.

Mark Cortazzo, an investment adviser in Parsippany, N.J., likens the extra cost to paying for car or homeowners insurance. "You'd be crazy if you didn't have homeowners insurance," he says. "You are paying for something I hope you never need." But you have to be careful, he says: The contracts are incredibly complicated, and "the vast majority I wouldn't recommend to a client."

7) Which trend is likelier in the coming year for variable-annuity buyers?

A. Higher prices, less choice among subaccounts
B. Lower prices, more choice among subaccounts

ANSWER: A. While annuities often get a bad rap for their costs, some analysts caution that insurers aren't charging enough to cover the cost of their guarantees. So annual expenses on the contracts are expected to rise. Some insurers also are looking to eliminate some of the riskiest offerings -- emerging-markets funds, say.

"Living benefits are potentially the riskiest liabilities the industry has ever underwritten," says Citigroup Global Markets analyst Colin Devine.

Some insurers offer only balanced funds, those containing a mix of stocks and bonds. For instance, Fidelity Investments last year launched a guaranteed-minimum-income annuity offering just two fund choices, each with about 60% invested in stock funds.

8) How many subaccount funds did variable annuities on average offer to investors in 2007?

A. 12
B. 22
C. 42
D. 52

ANSWER: D, according to NAVA.

9) True or false: Annuities are covered by the Federal Deposit Insurance Corp.

ANSWER: False. They are covered by state guaranty associations. Like the FDIC, the associations impose maximum coverage limits, and limits vary from state to state. Note: Money in the subaccounts of a variable annuity is legally segregated from the insurers' assets; if the insurer fails, the owner gets whatever is in the subaccounts. Most states provide at least $100,000 for the guaranteed portion of an annuity contract, according to the Web site of the National Organization of Life and Health Insurance Guaranty Associations, www.nolhga.com.

What if your account exceeds this amount? The value of a policy in excess of any statutory limit would be eligible for submission as a creditor claim in the receivership.

Mr. Cortazzo, the adviser, says buyers "definitely want to stay with the higher-rated carriers." The four highest ratings at insurance specialist A.M. Best Co. are A++, A+, A and A-. The other firms' highest grades are triple-A, followed by three categories of double-A.

10) Which of these statements describes a typical annuity owner?

A. The owner is female.
B. The owner is 66 years old.
C. The owner is -- or, if retired, was -- an owner of a business, or some other type of professional, such as doctor, lawyer or teacher.
D. The owner is in the middle class, with household income below $75,000.
E. All of the above.

ANSWER: E, according to surveys pulled together by NAVA.

—Ms. Scism is a news editor for The Wall Street Journal in South Brunswick, N.J.

Write to Leslie Scism at leslie.scism@wsj.com