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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 and How Does It Work?
A fixed annuity is a contract between you and an insurance provider. It can act as a safe place for cash to accumulate interest tax deferred.
You pay for a steady stream of income, and in exchange, the insurance company guarantees your principal plus a minimum interest rate.
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.
Income payments from a fixed annuity can be guaranteed for life, commonly referred to as a life annuity or single-life annuity, or for a set number of years, depending on the terms of the contract specifying the annuity payout options. Annuity contracts that pay income benefits for a set number of years are called period certain annuities or term certain annuities.
You may also elect to receive annuity income benefits as a lump sum.
Case Study Example
Who Should Get a Fixed Annuity?
A fixed annuity can be an attractive option for conservative investors planning for retirement like Kathy because these products offer a predictable stream of income. Kathy knows the rate of interest her money earns and how long it will earn that rate.
Another way to supplement later life expenses can provide peace of mind to people like Kathy who value security and stability over chasing high stock market returns.
Fixed annuities are more predictable and less complex than most other types of annuities, such as variable annuities.
This type of annuity is best suited for investors looking to preserve their principal — but who want their money to grow at a rate faster than a savings account or a CD can provide.
Accumulation and Payout
A fixed deferred annuity consists of two distinct phases: accumulation and payout.
After you decide to buy a fixed deferred annuity, the insurance company sets an agreement to pay you a minimum rate of interest when your account is growing. This is known as the accumulation phase.
During this phase, the current interest rate is applied. This annuity rate is guaranteed for that time period.
Interest in your account grows tax deferred during the accumulation phase.
The payout phase starts when you receive regular income from your annuity. Depending on your contract, you can choose to receive payments for a set number of years or the rest of your life.
What Goes into a Fixed Annuity Rate?
Unlike variable annuities and indexed annuities, fixed annuities are not linked to stock market performance or another investment.
Instead, your money grows at an interest rate determined by the insurance company.
When an insurance company receives your money, it adds it to its general account pool of incoming premiums. The company then invests that money — usually in government securities or high-quality corporate bonds that earn a slightly higher interest rate than the insurance company pays you.
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.
Some types of fixed annuities, such as multi-year guaranteed annuities, lock in the same rate for your entire contract. Others may adjust the interest rate after a certain time.
After the end of the set time period, another interest rate, known as the renewal rate, applies. You can ask your agent or broker for a renewal rate table to give you an idea of what to expect. However, even if the interest rate adjusts over time, it cannot fall below the guaranteed minimum rate specified in your contract.
Examples of Fixed Annuity Rates
|Product Name||Rate||AM Best Rating|
|American Pathway MYG 100k +||1.85%||A|
|Palladium MYG 250k+||2.15%||A|
|Platinum Assure 5||2.65%||A|
|MaxRate version 1 100k+||1.90%||A|
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Are Fixed Annuities Guaranteed?
An annuity is only as safe as the insurance company that sells it. While it is extremely unlikely an insurance company will go broke, it’s important to select an insurer with an A rating from one of the major insurance rating agencies, such as Fitch or A.M Best.
FINRA advises anyone shopping for annuities to contact their state insurance commissioner to ensure that their broker is registered and authorized to sell annuities in the state.
The regulatory nonprofit also suggests you find out whether your state has a guaranty association that will protect you if your insurer becomes insolvent.
Types of Fixed Annuities
Fixed annuities can be divided into three broad types: traditional, index and multi-year guaranteed.
Traditional fixed annuities, also known as guarantee fixed annuities, accumulate money based on a fixed interest rate set at the beginning of your contract.
Prevailing interest rates for fixed-income investments determine the initial rate. Your contract rate may be similar or higher than certificates of deposit (CDs) or government bond rates.
Insurance companies may increase the interest rate on your traditional fixed annuity contract after a specified period, such as two years. The new interest rate cannot fall below the minimum rate specified in your contract.
When shopping for a traditional fixed annuity, it’s important to find one that offers a competitive interest rate.
For example, some insurers may offer a renewal rate just slightly above the contractually guaranteed minimum. A relatively low interest rate may struggle to keep pace with inflation over time.
Make sure to carefully compare contract details before selecting a traditional fixed annuity.
Fixed Index Annuity
A fixed index annuity is linked to the performance of an underlying index, such as the S&P 500 or the Dow Jones Industrial Average.
These annuities limit both your potential losses and gains.
You won’t lose any money you put into a fixed index annuity unless you withdraw money or surrender the contract.
While you won’t lose your principal if the market downturns, you’ll also miss out on major upswings.
Fixed index annuities cap potential market highs. As a result, you won’t earn as much in strong years as you would investing directly in the stock market.
Fixed index annuities use several measures to control your gains and losses, including return caps and participation rates.
Multi-Year Guaranteed Annuity (MYGA)
A multi-year guaranteed annuity, or MYGA, is another type of fixed annuity.
MYGAs are very similar to traditional fixed annuities. The only real difference is the length of the guaranteed rate.
The interest rate for a MYGA is guaranteed for the entire contract term. There’s no risk that the insurance company will change the rate your money grows over time.
You can think of a MYGA like a fixed-rate mortgage: The rate is locked in and won’t rise or fall for any reason.
In contrast, other fixed annuities only guarantee the initial rate for a certain portion of the contract.
Imagine you purchase a 10-year traditional fixed annuity at a 4 percent interest rate. This rate will only be locked in for a specific time, such as the first five years. After that, the rate can increase or decrease, depending on the terms of your contract.
Meanwhile, the MYGA variety guarantees the 4 percent rate for the entire 10-year term.
Pros and Cons of Fixed Annuities
With any investment, it’s wise to consider the pros and cons before deciding which choice is right for you.
- Guaranteed minimum interest rate: A fixed annuity will never earn less than the guaranteed interest rate, regardless of the how the insurance company's investments perform.
- Premium protection: You cannot lose your initial investment, your premium, with a fixed annuity.
- Income for life: If you purchase a life annuity, you can never outlive your income payments.
- Simple: Unlike variable and indexed annuities, fixed annuities have no complicated formulas for determining the amount of money you will receive in income payments.
- 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.
- Lowest risk: Interest credited is not dependent on the performance of investments or stocks. 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.
Fixed Annuities and CDs
A certificate of deposit, or CD, is a savings security with a fixed interest rate and a specified withdrawal date, known as a maturity date.
Like a CD, a fixed annuity pays a guaranteed interest rate for a specific period, such as three to 10 years.
Fixed annuities and CDs are similar because you’re guaranteed to receive your principal investment back after a specific time — plus a certain amount of interest.
- Both are considered low-risk investments.
- Both offer various accumulation periods. However, CD accumulation phases tend to be shorter.
- Both protect your principal.
But several differences exist between fixed annuities and CDs.
For example, CDs are generally purchased through a bank or credit union, while annuities are purchased from an insurance company.
Fixed annuities often feature interest rates similar or slightly higher than CDs. Fixed index annuities, which are tied to the performance of underlying stock indexes, generate higher returns than CDS.
According to Forbes, the long-term expected return on a fixed index annuity is higher than CDs.
- CDs are typically purchased from banks or credit unions. Fixed annuities are purchased from an insurance company.
- Interest earned on a fixed annuity is tax deferred while CD interest is taxed as ordinary income for the year it’s earned.
- CDs impose high penalties if you withdraw money before the maturity date. With fixed annuities, many insurance companies allow you to withdraw up to 10 percent of your account’s value without a surrender charge. However, other annuity penalties may apply.
Fixed annuities can also offer more attractive tax advantages than CDs.
Unless a CD is purchased within an IRA or other retirement account, the interest it earns is subject to federal and state income tax each year.
In contrast, interest earned within a fixed annuity is tax deferred. You won’t pay tax on the interest until you withdraw it.
Comparing Fixed Annuities to Variable and Indexed Annuities
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|
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|
Questions About Fixed Annuities
11 Cited Research Articles
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