Fixed vs. Variable Annuities

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

The Difference Between Fixed and Variable Annuities

Annuities are an investment that can ensure long-term growth while preserving the underlying principal. There are several types of annuities to choose from that may be most effective in furthering your financial goals.

Two types of annuities are fixed and variable. Each has its own set of risks and benefits.

With a fixed annuity, your premium is placed in the insurance company’s general account and that money is mostly invested in different types of bonds. A variable annuity is connected to the performance of another financial instrument, such as stocks, mutual funds, precious metals or commodities.

Both fixed and variable annuities can be immediate or deferred annuities. Annuitants with immediate annuities begin to receive payments from the annuity shortly after purchasing it. Annuitants with deferred annuities don’t begin receiving payments for many years or even decades after they purchase the annuity.

Fixed Annuities

Fixed annuities offer a guaranteed payout because they have a set interest rate of return. For the first year of the annuity, the rate is fixed. After that, the insurance company can raise or lower the interest rate on a yearly or multi-yearly basis, but not below a guaranteed minimum. There is no upper limit on contributions, and taxes on the growth are deferred until withdrawal.

Fixed annuities come with a guarantee that you cannot lose your principal unless the insurance company fails.

If you are older than 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.

Fixed annuities have several payout options, including lump sum withdrawals, periodic withdrawals or a combination of the two.

Although they are considered a low-risk option, there are some risks associated with fixed annuities:

  • These annuities offer guaranteed payouts, but the payment is guaranteed by the insurance company that issued it, not the government. If the insurance company goes out of business, an annuitant could lose their money.
  • Annuities earn interest over time, but if the interest rate falls below the rate of inflation, the annuitant could lose spending power.
  • Without purchasing a costly death benefit rider, the annuitant may not be able to have a beneficiary receive the remainder of their annuity, should they die before receiving the full amount.

Fixed Annuity Fees

Fixed annuities, in general, are not known for carrying a number of fees. Still, there are some fees that can be tacked on to any type of annuity. Such fees include:

  • Surrender Charges – If you make withdrawals from your annuity within the first 10 years after you purchase it, the insurance company will charge you surrender fees. Surrender fees can run anywhere from 7 – 20 percent of the amount withdrawn in the first year, and decrease by one percent each year until it reaches zero.
  • Annual Fees – Annuities often carry annual insurance charges and investment management fees, which can range from 0.5 – 2 percent or more.
  • Commission – If you worked with a salesperson, they may earn a commission for selling you an annuity. Check in the fine print to see if you’ll be charged for their commission, which can go as high as 10 percent in some cases. To avoid paying commission, look for “direct sold” annuities.
  • Income Rider – Income riders are an added benefit on top of an annuity that guarantee a lifetime income stream. This added benefit has an added cost, which can include a contractual fee in addition to the annual rider fee.

Variable Annuities

Variable annuities are structured around the stock market and other fluctuating financial instruments, and therefore can fluctuate in profitability. When you purchase a variable annuity, your premium is 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 payout options. Just like fixed annuities, variable annuities can pay out in a lump sum, in smaller payments over time, or a combination of both.

Variable annuities are a higher-risk option than fixed annuities and, consequently, have some drawbacks:

  • The value of variable annuities is always at risk because it is tied to other financial products.
  • Without the purchase of extra, costly riders, variable annuitants are at risk of running out of money before their death, or losing their profits to the insurance company after death, depending on the performance of their annuity.

Variable Annuity Fees

In addition to the principal of the annuity, variable annuities also carry additional fees. Some fees specific to variable annuities are:

  • Administrative Fees – Variable annuitants receive regular updates on the status of their account. Insurance companies often charge a small fee — anywhere from .1 – .3 percent of the policy value — to cover the cost of this service.
  • Investment Expense Ratio – The sub-accounts your variable annuity are invested in will incur annual investment management fees, likely ranging from .25 – 2 percent of the policy value.
  • Income Riders and Mortality Expenses – Annuitants can eliminate some of the risk associated with a variable annuity by purchasing extra security in the form of riders. For an extra fee, income riders guarantee the annuitant will always receive a payment for the remainder of their lifetime, and mortality expenses provide a death benefit, so the annuitant’s beneficiaries may receive the remainder of their funds after their death.

Page Sources

  1. Anspach, D. (2016, August 23). 5 variable annuity fees to ask about. Retrieved from https://www.thebalance.com/variable-annuity-fees-to-ask-about-2389027
  2. Haithcock, S. (2013, September 3). 5 key questions on annuity income riders. Retrieved from http://www.marketwatch.com/story/5-key-questions-on-annuity-income-riders-2013-09-03
  3. Money magazine. (n.d.). Why are annuity fees so high? Retrieved from http://time.com/money/collection-post/2791254/why-are-annuity-fees-so-high/
  4. Updegrave, W. (2004, December 3). Safety first: Fixed vs. variable annuity. Retrieved from http://money.cnn.com/2004/12/03/pf/expert/ask_expert/
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