The Fixed Annuity
A fixed annuity is a vehicle that allows you, the annuitant, to deposit a lump sum that then generates a fixed rate of return for a set period. Both the principal balance and the interest rate are guaranteed by the insurance company issuing the contract, which provides a degree of stability for conservative investors or savers. Because the interest rate offered on a fixed annuity is often higher than conventional savings vehicles, a fixed annuity may be appropriate for long-term retirement savings goals.
The Mechanics of a Fixed Annuity
Fixed annuities are the most conservative of all annuity options given they function similar to a certificate of deposit. Once a deposit, or premium, is paid, the issuing annuity company sets the guaranteed interest rate for a period selected by the account holder at the time the contract is signed, ranging from one to several years. The interest rate does not change for the guaranteed period, but once that ends, the interest rate may adjust up or down based on current interest rates.
Fixed annuities may be deferred or immediate, depending on your needs. With a deferred annuity, you are delaying annuity income until a future date – usually one year or more from the initial contract date. While the fixed annuity remains deferred, interest accrues at the contracted rate. When income is needed, the annuity company will determine the guaranteed income amount based on your age and account value.
An immediate annuity is also a fixed annuity, but instead of paying a CD-like interest rate for a number of years, the annuity company starts paying out guaranteed income within one year. The income amount is similarly based on your age and account value, but the interest rate provided on an immediate annuity is less than what a deferred fixed annuity may offer.
Benefits of Fixed Annuities
The most apparent benefit of a fixed annuity is the protection against loss of principal, without the concern of market volatility. Fixed annuity contracts are not tied to an investment portfolio like indexed or variable annuities, but instead, offer a set interest rate that is backed by the issuing insurance company.
In addition to stable returns, fixed annuities also offer tax deferral for non-retirement funds. You have the option to purchase a fixed annuity outside the confines of a retirement account, like a traditional IRA, and in doing so, you achieve tax-deferred growth of your funds. You will, however, pay taxes on the interest earnings from a fixed annuity when the money is withdrawn as income or as a lump sum.
Fixed annuities also have low minimums, ranging between $1,000 and $10,000 depending on the issuing insurance company. Both immediate and deferred fixed annuities also offer annuitization options which guarantee income for your lifetime or a set period you select.
Considerations for a Fixed Annuity Purchase
A fixed annuity can be a suitable option for those looking for low-risk investment options that have the ability to generate fixed income now or in the future, but there are caveats to consider. First, fixed annuity interest rates are only set for a specific timeframe, after which they typically decrease. If the new interest rate is not amenable to your overall investment goals, it may be difficult to transition your funds to another savings vehicle. This is because fixed annuities, like indexed and variable annuities, come with surrender charges that may impede your ability to move the balance without paying a penalty.
A fixed annuity also comes with some risk, specifically in terms of interest rates and inflation. Locking into a fixed annuity during a low interest rate market may mean you give up the opportunity to secure a higher rate of return when interest rates are on the rise. In these scenarios, a fixed annuity may not keep up with inflation, leaving you with less purchasing power than you anticipated. And while fixed annuities do offer peace of mind given the set interest rate they provide, you do not have the opportunity for higher returns which may be available through other investment options, like stocks, bonds, or funds.
Fixed annuities are a sound method to achieve guaranteed growth of income based on a set interest rate, and they offer more stability than indexed or variable annuities might. However, it is important to understand how fixed annuities work along with the opportunity costs and risks involved before utilizing this vehicle as a retirement savings tool.