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A fixed annuity is a contract in which a purchaser pays an insurance company for a steady stream of income, and the insurance company guarantees the premium and a minimum interest rate. Designed for safety, fixed annuities are predictable and help people save and grow their money on a tax-deferred basis with lower risk than variable annuities.
Fixed annuities are the simplest and most straightforward type of annuities. They also provide the most predictable and reliable income stream, usually with the lowest fees.
A fixed annuity can be immediate or deferred. That is, depending on your contract, you may start receiving annuity payments within a year of purchasing your fixed annuity or you may have the payments start at a later time. Deferred annuities typically start payments at retirement.
In deciding whether a fixed annuity is right for you, you should consider how it works and how it compared with other types of annuities.
What Is a Fixed Annuity?
A fixed annuity is a contract between you and an insurance provider. A fixed annuity provides a way to save money over the long term, allowing interest to accumulate tax deferred.
You pay for a steady stream of income. The insurance company guarantees your principal and a minimum interest rate.
How Does a Fixed Annuity Work?
How the money in your fixed annuity grows will be spelled out in your contract. It may be by a set dollar amount, an interest rate or by another formula specified in the contract. Unlike variable annuities and indexed annuities, fixed annuities are not linked to the performance of a portfolio or another investment.
Income payments from a fixed annuity can be guaranteed for life or for a set number of years, depending on the terms of the contract specifying the annuity payout options.
You may also elect to receive it in a lump sum. This is known as a multi-year guaranteed annuity.
Fixed Annuity Pros and Cons
With any investment, it’s wise to consider the pros and cons before deciding which choice is right for you.
- Simple: Unlike variable and indexed annuities, fixed annuities have no complicated formulas for determining the amount of money you will receive in income payments. The rates and any changes are spelled out in the annuity contract.
- Predictable: Since everything is agreed on in the contract, you know what to expect. You don’t have to worry about whether an investment portfolio or the stock market are performing well. The interest rate is spelled out and guaranteed in the contract.
- Lowest risk: Since the interest is not dependent on the performance of investments or stocks, you don’t have to worry about losing money when stocks and other investments underperform. This is especially important for retirees, who can’t afford to lose the money they need to pay living expenses.
- No frills: The main disadvantage is fixed annuities do not have the potential that riskier annuities have of yielding greater interest rates if an investment portfolio or stock index does well.
- No inflation protection: Growth is fixed and may not keep up with inflation. That means their actual value may decline over time.
- No capital gains tax rates: Money withdrawn from annuities is taxed as ordinary income. It does not get the benefit of lower capital gains rates.
- Penalties for early withdrawals: Because annuities are designed to help people save for retirement, if you withdraw money from any annuity prior to age 59½, you will be subject to a 10 percent penalty.
- Surrender charges: If you don’t like the interest rates when they are reset and want to withdraw your money early, you may incur penalties.
Current Fixed Annuity Rates
When funds are building through interest or deposits — before payments begin — the annuity is in what is referred to as the accumulation phase.
During the accumulation phase of a fixed annuity, the current interest rate is applied. This annuity rate is guaranteed for that time period.
After the end of the set time period, another interest rate, known as the renewal rate, applies. The contract will provide details regarding how the renewal rate will be established.
Are Fixed Annuities Guaranteed?
Your fixed annuity contract will include a minimum guaranteed rate. The guarantee from the annuity company is that the interest on your fixed annuity will not dip below that rate. The company also guarantees the principal investment.
Overall, annuity funds are not guaranteed by the Federal Deposit Insurance Corporation or any other federal insurance agency. They are regulated and guaranteed by state insurance commissions.
Fixed and Variable Annuity Differences
Fixed annuities differ from variable annuities in the way the interest rates are determined. With fixed annuities, interest rates are clearly outlined in the contract. The growth rate of variable annuities depends on the performance of an investment portfolio.
The three main differences are:
|Interest is determined on the date of the contract||Interest depends on performance of investments|
|Low risk||Higher risk|
|Predictable, simple||Complicated, more difficult to understand|
Fixed and Indexed Annuity Differences
Index annuities combine the features of fixed and variable annuities. Here are the main differences between fixed and indexed annuities:
|Interest is determined on the date of the contract||Interest linked to performance of index, such as S&P 500. Guaranteed not to go below a certain level.|
|Lower fees||Higher fees|
11 Cited Research Articles
- Insurance Information Institute. (n.d.). What are the different types of annuities? Retrieved from https://www.iii.org/article/what-are-different-types-annuities
- Insured Retirement Institute. (n.d.). Fixed Annuity Calculator. Retrieved from http://www.irionline.org/research-and-education/educational-resources/retirement-tools-and-calculators/fixed-annuity
- U.S. Securities and Exchange Commission. (n.d.). Annuities. Retrieved from https://www.investor.gov/introduction-investing/basics/investment-products/annuities
- National Association of Insurance Commissioners. (n.d.). Buyer’s Guide to Fixed Deferred Annuities. Retrieved from https://www.naic.org/documents/prod_serv_consumer_anb_lp.pdf
- National Association of Insurance Commissioners. (2016, April). Issue Brief: Annuities. Retrieved from https://www.naic.org/documents/government_relations_annuities_issue_brief.pdf
- Financial Industry Regulatory Authority. (n.d.). Fixed Annuities. Retrieved from http://www.finra.org/investors/fixed-annuities
- Investopedia. (n.d.). Fixed Annuity. Retrieved from https://www.investopedia.com/terms/f/fixedannuity.asp
- CNN Ultimate Guide to Retirement. (n.d.). What is a fixed annuity? Retrieved from https://money.cnn.com/retirement/guide/annuities_fixed.moneymag/index.htm
- Anspach, D. (2018, April 1). How a Fixed Annuity Fits a Retirement Plan. Retrieved from https://www.thebalance.com/how-does-a-fixed-annuity-fit-your-retirement-plan-2389021
- Investopedia. (n.d.). Fixed vs. Variable Annuities. Retrieved from https://www.investopedia.com/ask/answers/093015/what-are-main-kinds-annuities.asp
- Carey, M. (2018, August 1). The Best Fixed Annuities Available in 2018. Retrieved from https://www.forbes.com/sites/mattcarey/2018/08/01/the-best-fixed-annuities-available-in-2018/#192bcfb64df1