Fixed vs. Variable Annuities

The are two types of deferred annuities: fixed and variable. An insurance company invests fixed annuities with bonds, while variable annuities are tied to stocks, mutual funds, commodities and other market indicators.

Financial advisors consider annuities a long-term investment that can ensure long-term growth while preserving the underlying principal. That said, not all annuities are the same.

There are two main types of deferred annuities: fixed and variable. Each has its own set of risks and benefits.

In a fixed annuity, your premiums are placed in the insurance company’s general account, and then mostly invested in different types of bonds. A variable annuity is connected to the performance of some other financial instrument: stocks, mutual funds, bonds, precious metals, commodities, etc.

Fixed Annuities

A fixed annuity contract is defined by its set interest rate. The rate is fixed for the annuity’s first year. After that, the backing insurance company can raise or lower the interest rate on a yearly or multi-yearly basis, but usually not below a guaranteed minimum. Taxes are deferred until withdrawal, and there is no upper limit on contributions.

Fixed annuities come with a guarantee that you cannot lose your principal unless the insurance company fails. If you are over age 59½, you can make annual withdrawals of up to 10 percent of the account’s value every year with no penalty (those under age 59½ pay a penalty to the IRS). Withdrawing more than 10 percent from the annuity in one year will result in a surrender charge paid to the insurance company. These charges decrease each year until they reach 0 percent, usually within 10 years.

Fixed Annuities and Different Income Options

  • You can withdraw money in a lump sum
  • You can withdraw money systematically over time until the account is depleted
  • You can annuitize the contract, which means you can take monthly distributions for a set time period, or for the rest of your life or the life of your spouse, even if those distributions exceed the principal contributed and interest earned

Risks Associated with Fixed Annuities

  • The failure of the annuity provider that issued the contract (unlike bank accounts, annuities are not guaranteed by the FDIC, or any federal agency).
  • The loss of spending power if the annuity’s interest rate falls below the rate of inflation.
  • The possibility that the insurance company may not be obligated to repay a surviving spouse if an annuitant dies after only receiving a few monthly payments.

Variable Annuities

As the name suggests, variable annuities come with fluctuating interest rates. Your premiums are put into various sub-accounts that align with your preferred level of risk. The value of your variable annuity will vary depending on the performance of the investment options you choose.

Similar to fixed annuities, variable annuities grow tax-deferred, have no upper limit on contributions and offer different income options during the income phase.

Unlike fixed annuities, however, your account is always at risk because it is tied to other financial products.

Variable annuities also often offer optional living benefit features that provide certain protections for payouts, withdrawals or account values against the possibility of investment losses and/or unexpected longevity.

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